With so much riding on your credit profile, you owe it to yourself to keep it in good shape. These days, everyone from insurance companies to potential employers review credit reports to measure creditworthiness. Therefore, doing the best you can to maintain a positive standing is important.
You’re probably already aware of some of the activities that will damage your credit rating, like making late payments, using too much of your available credit, and so on. But there are some other actions that can hurt your standing that you might not be aware of. For example, many people think that closing an unused line of credit will always have a positive effect on their score. This is not necessarily the case. When you close an account, you often reduce the amount of credit you have available, which in turn lowers your score. Thirty percent of your FICO score depends on the Amounts Owed category, which compares the amount of debt you have to the amount of your available credit. For example, if you had $15,000 in available credit and were using $5,000 of it, or 33%, you may not be in bad shape. But, if you were to close one of your cards, for instance one with a $5,000 limit that was charging you high interest, you’d be using 50% of your available credit.
Reducing your available credit adversely affects your score. For consumers with very low balances, closing newer credit accounts, slowly, can make sense – especially if the cards charge high interest rates or annual fees. On the flipside, leaving cards open without using them can also cause your score to drop. The FICO credit score looks at how recently information is reported. So, if you have an account you haven’t used in some time, the information regarding that account won’t be calculated into your score. If you leave the card unused for a significant period of time, your creditor may eventually close the card. Although it’s not a negative move in and of itself, it may easily be misinterpreted by someone reading your report. Make sure you know your creditor’s minimum usage policy so you can protect your open credit lines.
A few months ago, Fair Isaac and Company adjusted the algorithm used to translate the information in your credit report into a three-digit credit score. The new system, FICO ’08, weighs data differently than it has in the past. While the system would prefer to see minimal usage of credit, it would rather see many low balances on several cards rather than one or two large balances for the same amount. Therefore, those who charge a lot every month on one card and then pay it off actually hurt their credit score. How? The FICO scoring system doesn’t take the payments into consideration. All the scoring model recognizes is that each month you’re charging large amounts on an account.
Finally, taking on new credit affects your score in two ways. First, the inquiry generated by applying for a new account will slightly reduce your score. However, the larger concern is how the new line of credit lowers the average age of your credit history. For instance, let’s say you’ve had a single credit card for 10 years, but opened two new accounts during the past twelve months. The scoring system would average the length of time of all the accounts, making it appear that you’ve only managed credit for four years. How? Well first it would factor in 120 months for your longest held card. Then, it would consider 12 months each for your new cards. It would add all these months together, and then divide the total by 3 – the number of cards you have. Although you had actually used credit for a decade, the new calculation can reduce your score, since it makes you look like a less experienced borrower.
For more information, or to speak with a certified credit counselor please contact Cambridge Credit Counseling at 800-897-2200 or www.cambridgecredit.org.