How “Good” and “Bad” Credit Affect Your Credit Score

Is there such a thing as good or bad credit?  Or is how you use and manage your credit what really makes a difference in your credit score and how lenders perceive you as a good credit risk?  In my opinion, both concepts hold some degree of truth and they are interlinked.

There is no doubt that how you manage your credit (paying your bills as agreed) has a very substantial effect on your credit score regardless of the type of credit (automobile loan, mortgage, credit card, etc.) that makes up your credit file.  In fact, a common credit score fallacy is the assumption that missing a payment on your mortgage loan has a more substantial impact on your credit score compared to missing a payment on a credit card. Not true, holding all else equal.  The score focuses on the recency, frequency and severity of the missed payment, not the type of credit for which it has occurred.

[Related Article: Good Debt Versus Bad Debt]

While I don’t tend to categorize types of credit as of “good or bad,” the type of credit one has or uses can have a degree of impact on the credit score—some examples to consider:

• Generally speaking, revolving types of credit such as credit cards, department or retail cards or revolving lines of credit and how you use them factors more heavily into the credit score.  Being heavily utilized on your credit cards will likely have a more substantial impact on point loss compared to owing a balance that is close to the original loan amount on obligations such as car loans, student loans and mortgages.

• While the balance carried on a home equity line of credit can be factored into the score calculation, the revolving home equity line of credit will generally be by-passed/ignored in the credit score attributes that evaluate how utilized you are on your revolving credit obligations (your revolving balances divided by your revolving credit limits).   Revolving utilization information factors heavily into the score calculation.

• The interest rate you pay on your credit does not have a direct impact on your score as interest rate is not typically captured on your credit report.  As such information related to an automobile loan at 9% would be considered the same as information on an automobile loan that has a 4% interest rate.

While there are areas where the type of credit has a different impact on score, I would caution against trying to alter your credit profile with this insight as a means to increase your score. The key to having good credit is to consistently pay your bills on time, keep your credit balance low and only seek new credit when you really need it.

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