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Is a bank loan or credit card better for your score?

Erica Sandberg

August 20, 2015

QHi Erica,

Can you tell me what is the best thing to have to build my credit score: a bank loan or a credit card? I have one of each, but what I am asking is does one matter more to build up a score? How much does each one count to my score? I did go to myfico.com, not there. I did go to Experian, not there. I went to your columns, not there. It is driving me crazy that I can’t find that information.  —Todd

ADear Todd,

I’d love to slip you all the steamy details of exactly how a credit score is calculated, but I can’t. That’s insider information, and companies like the one that developed the ubiquitous FICO aren’t going to reveal their secret sauce.

Credit scores are products like any other items up for sale. Insurance firms, banks and card issuers purchase them so they can make objective decisions about their customers. If the FICO algorithm was made public, these businesses could take the data from the credit reports, plug it into the formula, then get the same result — for free.

FICO does publish a general guideline, however, which is enough for consumers to make decisions that will result in a high score. It’s similar in concept to the list of ingredients you’d see on a box of cake mix. With that you’d get something like “Wheat Starch, Salt, Dextrose, Polyglycerol Esters Of Fatty Acids (yum!),” etc., in order of what is most prevalent.Ask Erica

The ingredient list for FICO scores are payment history (35 percent). amounts owed (30 percent), length of credit history (15 percent), then types of credit in use and new credit (both 10 percent). The reason it’s divvied up this way is because these are the factors most important to lenders. Knowing this, you can draw accurate conclusions, including how loans might be perceived differently than credit cards.

As you’re certainly aware, credit cards allow you to pay for things over time. The credit limit is the amount you can spend up to, and you have a choice — you can charge a little or a lot, but you have to pay at least the minimum to keep it in good standing. To create a good credit score, though, you’ll have to pay on time and keep the balance to zero or very low. This way you’re proving that you’re using it as a payment tool, and not because you can’t afford what you’re buying.

With a loan, you borrow an amount of money and then pay it down in fixed monthly increments. If you make the payments on time, you’re doing great and your credit scores will rise. Just how many loans you can have outstanding before your score is impacted is not clear, but anyone looking at the report itself may balk when seeing substantial installment debt.

In short, payment history is the most important factor in a credit score and credit utilization is the second. All you have to do, then, is pay all financial obligations on time and make a habit out of paying your credit card bill in full. The more years you do both with a variety of accounts, the longer your positive credit history will be. Don’t apply for too many new accounts in a short span of time, as it is an indication that you’re desperate, and that never looks good.

Try not to complicate your life by agonizing over the details to which you are not privy. By asking yourself, “What would a lender want to see on a credit report?” you can get a pretty good idea about what goes into a credit score. It’s evidence that you’ve been borrowing and repaying, but always respecting the terms of the contract — and staying out of debt.

Got a question for Erica? Send her an email.

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