You’ve probably heard the phrase, “Don’t put all of your eggs in one basket.” This little bit of wisdom speaks to the value of diversification, which is (perhaps surprisingly) very important to your credit score.
You’ve probably been told to diversify your interests in the past, maybe even in an attempt to look well rounded for potential colleges. You’ve heard of diversifying your investment portfolio, which can help protect you against market downturns. But how many times have you been told to diversify your credit mix? And what does that even mean?
Well, there are a number of great reasons to focus on a well-balanced credit mix… not the least of which is your credit score. Here’s a look at why.
What Is Your Credit Mix?
When potential lenders look at your credit score, they are analyzing a few different things. They want to know that you have taken steps to get credit, have been responsible with the credit you’re given, and that you have experience managing different kinds of credit. The latter is called your credit mix.
This mix is comprised of all the types of credit that you successfully (or in some cases, unsuccessfully) manage. It gives lenders an even better view of where your financial strengths and weaknesses may lie, and can also help them to make a more informed decision before extending a line of credit to you.
While the breadth of your credit mix doesn’t in and of itself indicate whether you’ll repay a loan, it does speak to your experience in managing different types of credit in the past. As a result, your credit mix (the “different types of credit” category) makes up about 10% of your FICO credit score.
Why Does It Matter?
Your credit mix is a view of the types of credit-based accounts you use and manage. Each one is unique, too, and requires a certain type of financial handling. By demonstrating that you can handle a variety of credit types, you show that you are fiscally responsible across the board.
For instance, an auto loan is a fairly straightforward product. You pick the car, get approved for your loan, and drive off the lot with that new car smell. Sure, you need to pay back your loan in installments over the next few years, but it’s usually the same payment every month. It’s easy, payments are usually automatic, and you don’t even have to think about it.
A credit card, though, is very different. You not only need to worry about paying the bill each month, but you have to manage your spending, control your utilization, and not carry over a balance (even though you’re able to do so). It requires a lot more discipline to manage a revolving line of credit, so lenders want to see that you can do so responsibly.
How to Diversify Your Mix
Of course, I wouldn’t recommend going out and getting a home mortgage just to further diversify your credit mix. There are some easy ways to improve this area of your credit score, though, without putting yourself in financial hot water.
It’s smart to have at least one revolving account that’s open and current on your credit report. You can make this a rewards credit card and earn cash back on everything you buy each month, to further amplify its value. If you’re worried about going into debt, this card can simply be used a handful of times, paid in full, and then saved for a rainy day. But either way, having a credit card with healthy history is wise.
You can also consider a small installment loan, if you want to demonstrate that you can successfully manage such. This could be an auto loan or personal loan, and is particularly helpful if you plan to get something like a mortgage in the near future.
If you’re planning to consciously diversify your credit mix, though, there are a few things to watch out for. Applying for too many new accounts in a short period of time can set off red flags. While your intentions might be innocent, some lenders can see this as a sign of financial distress.
You should also keep an eye on your hard inquiries. These will stay on your credit report for a couple years; while a handful of them won’t hurt you, having a higher-than-normal number might also raise some eyebrows.
As they say, variety is the spice of life. And if you want the highest credit score you can achieve, you should work to ensure some variety on your credit report, too.
