When you’re going to apply for a mortgage, you’ll want to improve your credit score.
Most lenders use a FICO score model, which is calculated by the following weighted factors:
- Payment history (35%)
- Debts (30%)
- Length of credit history (15%)
- New credit (10%)
- Type of credit used (10%)
Many people aren’t sure how different types of credit can affect their score. However, with 20% of your FICO score being made up of new credit and types of credit used, it’s a good idea to pay attention to what kind of credit you’re using and how it can affect your score.
Your credit score does go down when there are credit inquiries on your account. Opening new accounts is important to establishing credit, but opening a lot of new accounts in one time period makes lenders nervous. If a lender sees that you’ve opened several new lines of credit over the past six months, it tells them you can’t manage your budget or can’t pay off what you owe. For that reason, you don’t want to open up new credit lines before going to a lender.
Additionally, taking on new credit lowers the average length of your credit history (which is 15% of your FICO score).
A note on loan shopping
If you do need to get new credit—like a mortgage—you want to shop around. Typically when a creditor makes a credit inquiry, it dings your credit. That’s not true when you’re loan shopping.
If you visit three car dealers or three lenders in a short period of time (keep it to about two weeks to be safe), you will lose points on your credit score for only one credit pull.
Type of credit used
Having a mix of credit helps your score. It shows you’re more responsible and can handle different kinds of debt.
Examples of debt FICO considers for your mix of credit:
- Secured debt – those with collateral attached, like a mortgage or auto loan
- Unsecured debt – a debt with nothing put up for collateral, like a traditional credit card
- Revolving debt – debts that you can pay off and borrow from again and again, like a credit card
- Installment debt – debts that must be paid off over a length of time with set monthly payments, like student loans
Secured debt is also seen as a little more favorable than revolving debt because you have property on the line. If you don’t pay, you lose something, so you’re more likely to pay.
Revolving debt is usually the kind of credit that gets buyers in trouble, so lenders don’t want to see a whole bunch of it. Try to keep your credit cards with a maximum usage of 30%.
Installment debt is seen as a little safer because you’re on a set schedule, unlike revolving debt. Some types of installment debt, like student loans, are considered better debt than something like a new boat or expensive television.
Of course, if you have poor credit, the best idea is to pay down your loan instead of opening up a different kind of debt. It’s optimal to keep your credit card debts at no more than 30% each month and a debt-to-income ratio of less than 43% when looking for a mortgage.
For more smart financial news and advice, head over to MarketWatch.