Credit Improvement: The Types of Accounts in Your Credit Report... What's Right and What's Wrong

In the past two months we explored Payment History and Your Amount of Debt and their level of impact to your credit scores. So far we’ve identified 65% of the points that make up your credit score as being generated out of these two categories. This month we will look at one of the lower value categories: the types of accounts in your credit report. This category makes up 10% of the points in your credit score. So, while it’s certainly not a priority to address, anyone who has hopes of maxing out their credit scores should pay attention.

The definition of “types of accounts in your credit report” is a little confusing. In this country lenders are not required to report your accounts to any of the credit bureaus. As such, not all of your accounts will show up on your credit reports. If an account does not show up on your credit reports then you will get no positive credit for it in the credit bureau scoring models, such as a FICO® Credit Score. What the scoring models will take into account are all accounts that are on your credit reports and the type of an account that it is.

There are many different types of accounts that can show up on your credit reports. Some of the most common examples are:

Revolving Accounts

Revolving accounts are those that have a different payment each month depending on your current balance. These are accounts that you are not required to pay in full each month. You have the option to “revolve” some or all of the balance to the following month. Lenders charge you interest on the amount that you revolve and this is how they make money. Some examples of revolving accounts are:

• Credit Cards Issued by a Bank or a Credit Union – These are commonly referred to as Visa® or MasterCard® accounts because of the logo that appears on the front or back of the card. These are extremely common because almost all banks and credit unions are able to issue them to their customers. Remember, credit reports will keep a history of your accounts even if they have been closed. As such, most consumers have several of these accounts on their credit reports.
• Credit Cards Issued by a Non-Bank – These are accounts that are issued by financial institutions that you do not use for your personal banking. Some examples are Discover® Card, and American Express®. These are also extremely common in part because they are so heavily marketed. Most consumers have or have had at least one of these cards. So, it is likely that one or more of these accounts will show up on your credit reports.
• Credit Cards Issued by a Retail Store – These are accounts that are issued by the stores where you like to shop. These cards are a little different than the previous two types in that you can only use the card at the store that issued it. Some examples are Macys® Card, Target® Card, Pep Boys Card® and a Dillard’s® Card. There are hundreds of other examples. Most of us have several of these types of cards.
• Credit Cards Issued by an Oil Company – These are accounts that are issued by a petroleum company. As with retail store accounts these cards can only be used at specific locations, almost always a gas station. Some examples are Texaco® Card, Exxon® Card, Shell® Card and BP® Card. These cards are also very common and easy to obtain. Most of us have or have had several of these types of cards.
• Home Equity Lines of Credit – Also known as a HELOC, these are loans that allow you to tap into the equity of your home. These loans are generally easy to obtain from most reputable banks and credit unions. Since these loans allow you to access a portion of your home’s equity, the payment is determined by the amount borrowed or used. These accounts are very common in part because the interest is tax deductible in most cases. Check with your tax advisor to see if your account qualifies for a tax deduction.

Notice - For your information, debit cards (also known as check cards) are not considered true credit cards. They are essentially nothing more than a check in the form of a credit card. As such they do not report on your credit files and will have no impact, good or bad, to your credit scores.

Installment Accounts

Installment accounts are those that have a fixed payment for a fixed period of time. As with revolving accounts you are not required to pay them in full each month. You are allowed to make a payment that is going to be the same every month until the loan is paid in full. Lenders charge you an annual percentage rate (also know as an APR) and this is how they make money. Some examples of installment accounts are:

• Auto Loans – Auto loans are issued by either a bank, credit union or by a company that specializes in automobile lending. These accounts are generally paid off over 48 to 60 months but shorter and longer terms are available.
• Mortgage Loans – Mortgage loans are issued by either a bank a credit union or a company that specializes in mortgage lending. These accounts require the most amount of paperwork during the application process but are generally easy to obtain even with marginal credit scores. Some examples of companies that specialize in mortgage lending are Countrywide®, HSBC Mortgage®, Washington Mutual® and Wells Fargo Mortgage®.
• Student Loans – These loans, obviously, are used to pay for college related expenses such as tuition, room and board. Some banks will issue student loans and the Federal Government guarantees a portion of them. Student loans are a unique type of loan because most students are taking classes and not working full time jobs. As such, the repayment of a student loan generally goes through a process called “deferment.” Deferment essentially allows the student to postpone their payments until several months after they have graduated or stopped going to school. This gives them the opportunity to secure employment before the loan requires the first payment.
• Home Equity Loans – These are not the same as home equity lines of credit (aka HELOCs). Although they both allow you access to your home’s equity the structure of the loans are not similar. A home equity loan is a fixed amount of money that you borrow. Once you take that loan out your payment is fixed for the duration of the payback period. Whereas a home equity line of credit gives you the flexibility of taking out some of or the entire approved amount.
• Signature Loans – Signature loans are just what they sound like. You walk into a bank or credit union and tell them you want to borrow some money and sign a guarantee to pay it back. You don’t have to tell the bank what the money is for and you can use it for anything you like including vacations, investments, home improvements or a shopping spree.

Open Accounts

Open accounts are probably the least common of the three we’ll profile. An open account has no credit limit and you have to pay back the full amount at the end of each month. Your payment will vary depending on how much of a balance you run up each month. Some of the examples of the few remaining Open accounts are:

• Cellular Service Accounts – Yes, there are some cellular service providers that report your account to the credit bureaus each month. Your balance is based on the amount that you use each month. And, you are required to pay back the full amount each month.
• Other Home Utilities – A trend that seems to be gaining momentum in the U.S. is the use of credit data to set deposit requirements for home utilities such as gas, power, water and cable. The amount you pay each month is determined on your previous month’s usage. While it is unlikely that you will see your utilities on your credit reports consistently, it is happening on a more frequent basis.

Every single account on your credit files will fall into one of the categories above: Revolving, Installment or Open.

Why does your mix of accounts matter?

When these accounts report on your credit records they are coded very specifically so that not only consumers and lenders but also credit scoring models can easily identify them. As such, it is possible to determine if the types of accounts you have are indicative of your future level of credit risk. Statistical analysis has determined that, albeit a weak correlation, the type of accounts you have is predictive of your future credit risk.

So what does all of this mean to you the consumer? What it means is that your scores, namely your FICO credit scores, can be negatively impacted by having the wrong mix of accounts on your credit reports. The good news, however, is that your scores can be improved by having the right mix of accounts.

How is that mix measured?

Quite frankly, they are counted. It’s as simple as that. Actually, it’s not quite that simple. What makes “Type of Accounts” predictive is that you can actually have too many of one kind of account or too few of another type.

When your credit files are scored by the credit scoring models they look at all of your account and tally them up by type. You could, for example, have 20 total accounts; 8 credit cards, 3 mortgages, 4 car loans, 4 student loans and one boat loan. These same 20 accounts could also be categorized as 8 revolving accounts (the credit cards) and 12 installment accounts (the mortgages, car loans, student loans and the boat loan). You may think “that is an unrealistic example.” However, all of the historical accounts on your credit reports are counted too. Most of us have had several credit cards, mortgages, auto loans and student loans in our life so this example is probably very realistic.

You want this mix to be as diverse as possible with a couple of notable exceptions. Here’s why:

The Impact to Your FICO?® Credit Score

The FICO® Credit Score is the standard credit scoring model used in today’s lending environment. Each of us has three different FICO scores, one generated from each of our three credit reports. It’s important to become familiar with the impact your amount of debt has on your credit scores.

These measurements taken about the type of accounts in your credit reports are then “scored” and become a small portion of the points in your credit scores. This component of the score requires a little more thought than the previous two categories. The points you earn for the two primary categories (Payment History and Your Amount of Debt) progressively decreases as their measurements increase. For example, the more late payments you have the fewer points you earned. The higher your debt load the fewer points you earned. This is what is referred to as “directional.” Alternatively, the “Type of Account” category only makes up 10% of the points in your score however it’s tougher to put your finger on the exact “right” amount of different types of accounts.

There really isn’t one target “sweet spot” that we should all aim for in our account mix. That’s because your mix of accounts might be great for your score but terrible for someone else’s and vice versa. This is a “non directional” category.

How can you ensure earning the maximum points available out of the Types of Accounts category?

Here are some simple steps you can take to ensure earning the most points out of this category:

• You must have a mortgage - That’s right. If you have a mortgage account on your credit reports then it is likely that you will earn more points from this category than someone who does not. Statistics show that consumers who have mortgages tend to show an increased degree of stability and credit responsibility than those who do not.
  
• Avoid finance companies - Finance companies are commonly referred to as “lenders of last resort.” Their rates and terms are not as favorable as those offered by banks and credit unions so higher risk consumers tend to depend on them for their credit needs. As such, having a finance company account on your credit report could cost you points.
  The old argument against this was that banks didn’t do business in rural parts of the country so people had to do business with the local finance companies. This argument doesn’t hold water any longer especially with the staggering growth in loans that are granted via the Internet.
  Simply put, you can live in Alapaha (population 2,500 in rural Georgia) and still apply for loans from Chase Manhattan Bank, headquartered in New York City or from Wells Fargo, headquartered in San Francisco. There are no excuses for doing business with finance companies. Don’t lose points by doing so.
  
• Not too many credit cards - While the correct number of credit cards that we should have isn’t available, it’s safe to say that the more you have the closer you are getting to losing points in this category. Have only as many credit cards as absolutely needed so that you can function efficiently and don’t get any more. You could get away with having one or two cards that would be accepted by every retailer and service provider in the country so having 10 credit cards simply isn’t necessary. It’s not a status symbol to have every card available. It’s bad credit management.
• You’ll eventually want to finance a car - It’s cheaper to pay for things in cash. That’s the simple truth because you don’t have to pay interest. However, in the world of credit scoring having a car loan (old or new) as part of your credit mix is a good thing.

Next…the length of time you have had credit and what you can do to ensure maximum points from this category.

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