I got credit everywhere
Types of credit and the importance of a diverse blend
Not all credit is the same, and not all credit is created equal. So applying a generic understanding of credit, is a great way to set yourself up for many unpleasant lessons. We’ve already reviewed the basics of credit, what it is, and explored some real life scenarios where it is factored into decisions made regarding your finances. However, that is far from all there is to know about credit. So the best thing we can do is to explore and continue diving into the mystery of credit.
The three primary types of credit are revolving, installment, and open credit. Each type of credit has it’s own set of characteristics and benefits. Ideally, the goal is to have a diverse blend of all types of credit. As a way to show creditors that you can responsibly manage a variety of obligations. This is not to be interpreted as a way of saying that you are obligated to constantly maintain open accounts in all three categories. After all credit mix typically does not account for a large portion of the overall credit rating. However, having a diverse blend still has many advantages.
Credit as an installment, is easily seen when thought about in relation to loans that have a fixed payment schedule. This would include car loans, and home equity loans. For installment loans, a set amount is borrowed, and gradually paid off via agreed payments over the course of the repayment timeframe. Unless otherwise stated, you are free to make larger, or more frequent payments to accelerate the repayment period. Which can save you a considerable amount of money, given the interest you don’t have to pay otherwise. It is advisable that you read the terms of the loan, as some institutions may charge a penalty for paying off the loan early.
Revolving credit is another form of credit, that you may already be familiar with, for example credit cards, or lines of credit. With this form, you are given a maximum financial limit that can be borrowed. As you borrow from the available funds, the creditor will assign a minimum required payment that is to made until the balance is paid in full. Usually this payment is a monthly, occurrence, for as long as the balance is left. Revolving credit is available until the full amount has been used. The decision to carry a balance into the next month, or fully pay the balance each month is at your discretion. However, if there is a balance remains, the new balance will factor interest and fees that will be added to the pre-existing balance. With revolving credit, the objective is to avoid carrying balance, as much as possible.
Open credit, is the third type of credit, and just like the others that have been discussed, open credit also has common real-world applications. Open credit accounts are a bit trickier than installment and revolving accounts. With installments the loan repayment is mutually agreed on between the lender and the borrower. Whereas with revolving credit, the lender specifies a cap-amount available and it is generally due in payment soft-limit amounts. Open credit accounts are accounts where the service is provided on the front end and the payment is due on the back end, and almost always due in full. An example would be a utility company, the service is provided, and you are billed for the service you consumed. And it is expected that the balance will be completely paid prior to the next due date.
If you have all three types of credit and use them responsibly, then yes, your credit score may benefit. If you don't have all three types, you can still achieve an excellent credit score. Having a diverse blend of credit account types shows lenders that you are financially responsible with handling different types of accounts. Showing that you can make minimum payments (or more), keep up with installment payments, and pay off open credit lines gives lenders a favorable opinion of you.
Diversify your credit accounts and stay on top of each of them in order to maximize your credit score. If you have all three types of credit and use them responsibly, your credit score will benefit. Using them irresponsibly, though, may have the opposite effect.
