Understanding Types of Credit – What They are and How to Use Them
By Taylor Milam
Reviewed by Lauren Bringle, AFC®
Like most Americans, you’re probably interested in increasing your credit score. But here’s the deal — nothing is more confusing than trying to understand your credit report for the first time.
You have to dig through pages of information to try to understand what makes up your credit score
, and even then, the three-digit number can seem random.
Luckily, credit scores — and their calculation — are not as confusing as they first seem. In fact, there’s been a big shift in the way Americans interact with their credit scores and a lot of that’s due to consumers having increased access
to free scores.
The result? Increased credit literacy.
According to a recent report
from the Consumer Federation of America, the number of Americans who have accessed their credit score
increased by 9% in the past year.
Even beyond that, the majority of respondents were able to correctly identify three important factors used to determine credit scores: missed payments, high balances and bankruptcy.
But there’s still one major credit score factor that causes confusion – the types of credit you use, otherwise known as your credit mix. Despite increased credit literacy in some areas, many consumers are still unaware of the power this knowledge could unlock for them, so we’re lifting the veil.
Here’s everything you need to know about types of credit, minus the financial jargon.
How many types of credit are there for consumers?
It may seem like there are endless types of credit to choose from at your local financial institution, but there are actually only two types of credit: revolving accounts and installment credit.
Oliver Browne, a credit card analyst at Credit Card Insider
“Revolving accounts allow you to borrow over and over, up to an approved amount. The amount is set by the lender, but it’s up to you how much you want to borrow at a given time. The prime example of revolving credit is a credit card. There are usually minimums that you must pay, but you can usually decide to pay more. For example, if you have a minimum payment of $200 for your credit card, you can decide to pay a larger amount, like $500 towards the balance instead.”
The most common types of revolving credit accounts
- Credit cards
- Home equity lines of credit (HELOCs)
- Retail credit cards
Basically, as long as you use them responsibly, revolving credit includes accounts that stay open until you close them.
“Installment credit is when you borrow from a lender for a fixed amount with fixed payments. This credit type includes student loans, car loans and personal loans,” explains Browne.
Installment credit usually takes the form of a loan, like a mortgage loan or student loan
. When you open the loan, you agree to borrow a certain amount of cash from the lender. For example, if you’re buying a used car, you might agree to finance the car from the dealership and agree to open a $10,000 loan.
The terms of the loan state how much your monthly payment will be and how long you’ll make payments. In other words, you make regular installments – or payments – towards the loan balance to the financial institution or lender.
The most common types of installment credit include:
- Mortgage loans
- Auto loans
- Personal loans
- Student loans
Do all types of credit affect your score?
“In most cases, yes. Installments and revolving credit are going to affect your credit score. If you miss payments, it could drop your score,” Browne says.
In fact, one of the primary things all types of credit have in common is that they can affect your credit score.
“If you don't pay installment or revolving, you’ll likely see a decrease in your score. If your payment behavior is bad for either type of credit, you’ll likely see a decrease,” explains Browne.
This is because payment history has the largest impact on your credit score and counts for 35% of your FICO credit score. So whether or not you pay (or don’t pay) makes a big difference.
But it’s not only negative activity that can affect your score. Positive activity or habits can also affect your score for both types of credit as well. That’s why it’s important to confirm that your lender reports positive activity as well.
“When you apply for a credit card [or loan], make sure that your lender reports positive activity to the credit bureaus. You need to ask, ‘If I pay my bills on time every month, are you going to report positive activity and behavior to the credit bureaus?’ If you’re not checking, you’re wasting an opportunity to build credit,” advises Browne.
How many types of credit should you have?
Ideally, consumers should have each of the two different types of credit. In terms of your FICO score, the best situation is to have both revolving credit and installment credit, especially if you are trying to build your credit score
“The way this works is it’s best to have a variety of different types of accounts because they will more positively impact your score, rather than just having one type of account. Variety of accounts makes up about 10% of your FICO credit score. If you’re showing that you can maintain and manage diverse accounts, it will look even better,” says Browne.
Basically, lenders want to see that you can responsibly manage different types of credit, because it indicates you could be a lower risk to them if they decide to loan you funds.
Experian backs this up. According to Experian
, one of the major credit bureaus
, consumers often overlook credit mix and its importance. But here’s why it matters and how it can affect your credit history:
“Maintaining different types of credit accounts, such as a mortgage, personal loan and credit card, shows lenders you can manage different types of debt at the same time. It also helps them get a clearer image of your finances and ability to pay back debt. While having a less diverse credit portfolio won't necessarily cause your scores to go down, the more types of credit you have—as long as you make on-time payments—the better.”
How to build credit
If you’re interested in building your credit score or improving it, Browne says that the first step is simple: learn more about it.
“If you’re looking to build your credit, read up on basic credit terms and make sure that you know how credit works. Stay updated with the major credit bureaus and review your credit on a frequent basis as you try to build your score. It’s also a good idea to get copies of your report because errors can occur sometimes, so always keep an eye on them.”
Luckily, it’s simple to get a free copy of your credit report
. You can visit annualcreditreport.com and ask for a copy online, or you can call 1-877-322-8228
to get a report. You’re entitled to one free report per year from each credit bureau.
While you can read the blog on How to Build Credit for a more detailed guide, here are some basic steps you can take to improve your credit score:
- Pay your bills on time: It might seem obvious, but one of the quickest ways to improve (or maintain) your score is to pay your bills on time, every time.
- Get up-to-date: If you have any payments that are late or in collections, getting them paid is one of the quickest ways to make sure your score doesn’t drop.
- Dispute mistakes: If you catch any mistakes on your credit report, make sure you file a dispute with both the credit reporting agency and the information provider (the bank or loan provider). According to the Federal Trade Commission, it’s best to correct a mistake via written letter, and they even offer templates you can use.
- Decrease new requests: If you’re interested in boosting your score, it might help to limit the number of hard credit inquiries on your account. Before you apply for credit, be sure to consider the impact that a hard inquiry might have on your score.
- Consider a secured credit card: If you need to build credit, it might be a good idea to consider a secured credit card to build credit. A secured credit card might be able to help you get started on your credit journey.
- Or, if you need an installment loan, consider a credit builder loan such as Self, which is also available via some local credit unions.
Regardless of where you are on your credit journey, the good news is you’re now equipped with what you need to know to build or maintain your credit score – or at least where to find the resources you need. You might even already have a healthy mix of credit types without realizing it.
The best way to know for sure is to check your credit report (but first, make sure you know how to read your credit report
). But even beyond that, the most important thing to remember is that you’re in control of your financial future (and your credit score). So if there’s something you need to change, take action to make it happen. After all, you’re the only one who can.
About the author
Taylor Milam is a personal finance writer who has also written for Credit Karma, Chime, Acorns and Policy Genius, among others. See Taylor on Linkedin
About the reviewer
Lauren Bringle is an Accredited Financial Counselor®
with Self Financial – a financial technology company with a mission to help people build credit and savings. See Lauren on Linkedin
Our goal at Self is to provide readers with current and unbiased information on credit, financial health, and related topics. This content is based on research and other related articles from trusted sources. All content at Self is written by experienced contributors in the finance industry and reviewed by an accredited person(s).