The credit experts at Credit.com recently received an inquiry with the question:
“Do different types of credit cards affect my credit score differently? So many people shop by credit card category — they want good travel rewards or a 0% balance transfer. But do different credit card types signal different things to lenders about a cardholder’s creditworthiness?”
The short and direct answer to this question is a pretty simple one. And, as always, a good question opens doors to other good questions.
When evaluating debt, credit scoring formulas through their various calculations tend to consider cards differently than loans, and credit utilization (balance/credit limit ratio) differently between retail, charge and credit cards. But as to whether they distinguish between one type of credit card and another, they don’t.
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While this trend toward equality within the scoring formula may not necessarily make the credit card snobs happy — though they still have their 0% balance transfers and quadruple rewards to enjoy — it should bring some degree of satisfaction to people in the new-to-credit and rebuilding stages, who may currently only aspire to credit card snobbery.
Specifically, the good news here for people working to build or rebuild their scores is that a secured or “rebuilder” credit card can be expected to have the same impact on a credit score as a “prime” card having the same age, payment history, balance and credit limit.
With that question answered, the mention of other types of cards — retail and charge — provides the opportunity to look more closely at some differences in how retail (department store, gas), charge (travel and entertainment) and credit (bank) card accounts are considered by the scores used in most lending decisions, FICO.
Retail vs. Credit Cards
It’s well known that maintaining a low credit utilization percentage is an important part of a good credit score. What may not be so obvious, though, is that retail card credit utilization tends to play a less-important role in your score than credit card utilization. For this reason, to maximize an already good credit score achieved in spite of having no credit cards, consider adding one or two bank issued credit cards to your credit mix to get the most out of your low utilization.
Charge vs. Retail and Credit Cards
With the latest FICO credit scoring models, charge cards are not included in credit utilization calculations, which only seems right, since they provide an “open” — not revolving — line of credit that typically requires payment in full within 30 days after the statement date and have no established credit limit.
While making sense, excluding open type credit accounts from credit utilization calculations hasn’t always been the case, and is still not the case with some of the older scoring models currently in use by lenders. As lenders have traditionally been slow to adopt new credit scoring models, many continue to use older models that include charge card accounts in credit utilization calculations, by comparing the account balance to the card’s highest-ever balance in place of a credit limit.
While clearly the impact of including charge cards in credit utilization can go either way — favorable if low, unfavorable if high — for a consumer whose score is being calculated from an older model, it’s easy to see how a charge card currently at its highest-ever balance can do serious damage to a score.
For this reason alone, many people intentionally put a large purchase on a charge card simply to raise the high balance amount, so that future purchases will take up a smaller proportion of the high balance amount and result in a lower utilization percentage when scored using an older formula.
What better time to understand how the various types of cards do and don’t impact your credit scores as Black Friday and the holiday shopping season approaches!
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Image: Natloans, via Flickr