The importance of a CIBIL score can no longer be ignored. In most banks and financial institutions it has become a norm to check this three-digit magical number before sanctioning any kind of loan. After all banks want to secure themselves against any potential losses and therefore they want to be sure that the applicant has the ability and the interest to honour the debt. The CIBIL score, they believe, is the prime indicator of the creditworthiness of the applicant and a reflection of his future credit behaviour.
If you are planning to take a loan in future you would surely be looking at getting your credit rating up. There are various factors that determine your credit health including the payment history, credit utilization ratio, age of accounts, derogatory remarks and the credit mix. How you score in each of these categories will go a long way in determining your score. Though making payments on time and keeping debt levels low make up for 65% of your score they are not the only things that you should be worried about. If you are strategizing for a perfect score to get the most attractive interest rates then you need to pay attention to the credit mix that determines 10% of your score. Credit bureaus find that a person with a healthy balance of usage of various types of accounts is a lower risk to the lender. Hence a credit profile which shows diversity in the type of credits is preferred to the one that is dominated by only a single type of account.
Let’s see how this credit mix factor works. There are basically two types of accounts namely instalment accounts and revolving accounts.
Instalment accounts require a fixed monthly payment. The amount is borrowed for a set period of time and a fixed rate of interest is charges over the duration of the loan. Student loans, car loans and home loans fall in this category.
Revolving accounts require a different amount of payment each month depending on the amount of credit line you have utilized. You need not pay the full balance each month, rather you revolve some balance to the next month and pay interest on that balance. The most common examples of revolving accounts are credit cards and home equity line of credit.
The scoring models reward people who have a blend of both these type of accounts in their credit profiles. If you wish to demonstrate that you are a responsible borrower and attain a perfect credit score you need to showcase your skills at managing both these types of accounts.
If you only have an instalment account then you can apply for a credit card, charge a few expenses every month and pay off the balance at the end of the month. If your credit profile is dominated only by credit cards you can think of adding some variation to your finances by taking an instalment loan next time you are in need of funds. Taking a personal loan to consolidate your high interest credit card debts may also be a good option.
In general an instalment account enhances the perception of your credit experience. It shows that you have the maturity and responsibility to make steady payments over time.
Having said that, we still don’t recommend taking on a finance that you don’t actually need, or you won’t be able to repay just to improve your credit mix. It doesn’t make sense to pay interest for a small payoff. It is best if credit diversification happens naturally on need basis. Also, if you are just starting your journey of building credit then diversifying your credit mix may not be your first priority. Instead you should focus more on bigger areas like building a good payment history and lowering your utilization rate.
There is no doubt that the experience of managing both types of accounts instils a sense of confidence about your ability to manage your credit. It can bump up your score from 20 to 40 points, so you can definitely keep an eye on the type of accounts you have if you want such a boost in your credit score. Once you take on new loans to improve your credit mix remember to keep track of due dates and stay on top of payments. Late payments will do more damage to your profile than a lack of variety of accounts.