As the economic downturn continues, many people contact our agency looking for information about how to increase their credit score. Although no credit counseling agency can advise individuals specifically about how to repair their credit, we do hear some interesting “facts” people have learned from friends and family members. Sadly, much of what we hear is inaccurate, so I was encouraged recently when I happened to read a blog-post from Fair Isaac and Company that addressed some of the misinformation people have about increasing their scores.
Fair Isaac and Company’s Senior Director of Global Scoring Solutions, and a member of FICO Labs, Rachel Bell, discussed some of the misconceptions about raising a credit score. Before we address those myths, let’s take a refresher on the five elements that make up your credit score. Your payment history counts toward 35% of your score and looks at how you’ve maintained your obligations over time. Amounts Owed makes up 30% of your score, and is fairly self explanatory. Length of Credit History accounts for 15% of your score and considers how long you’ve been using credit, and your most recent activity. New Credit and Types of Credit Used each make up 10% of your score. New Credit evaluates the most recent accounts you have opened and Types of Credit considers the mix of accounts on your profile – credit cards, mortgages, student loans, etc.
Okay, now that we have covered the factors impacting your score, let’s bust some of these credit myths. The first issue Ms. Bell addresses is that in order to improve your score, you must have high balances on your credit accounts. Thirty percent of our credit profile is weighed against the amount of debt we carry. The more debt we have, relative to our credit limits, the more our score is adversely affected; therefore, having high balances is not helpful to our score. Another interesting fact from Ms. Bell’s blog is that paying off your accounts in full may not be as helpful as you’d think, if we then immediately charge again on those accounts. As Ms. Bell states, this is a fantastic habit that will help you reduce the hold that credit has on your financial life, but it may not do much to increase your credit profile. According to Fair Isaac, their model “rarely reflects” our most recent payments. It’s not to say their model is deficient, just a fact related to the way creditors report to the bureaus. Many lenders report the previous outstanding balance billed to the customer; therefore, paying your bill off may still leave a notation that you are carrying a balance with your creditor. Essentially, your creditor will report the account balance for the last billing period, and not the payment that would have brought your obligation to zero.
The next myth is one that has existed for quite awhile. Some people are convinced that opening new credit accounts will raise their score quickly. This is not entirely accurate. There are some benefits to opening a new line of credit, but they’ll take time to be reflected in your score. The new account may improve your utilization rate and add variety to your profile, although the latter is minor consideration when establishing your risk factor. However, you can also lose points because the account will count as New Credit. That loss should be temporary and should work itself out within a few months.
Similar to the last myth, I’ve heard this next one on many occasions. It was once believed that closing any unused credit cards would quickly increase your score. In all fairness, the lending community touted this maneuver for decades; unfortunately, it’s not the case. The FICO scoring model actually considers unused credit as a positive factor. You see, although you have access to these credit limits, you’re not using them. From a risk perspective, that’s a good thing. When you close an unused account it no longer counts toward your profile, which will raise the percentage of available credit you’re using and reduce your score.
As you can see, the world of credit is not as cut and dried as many of us may think. For more of Ms. Bell’s insights and some other great information about credit, please visit FICO’s bankinganalyticsblog.fico.com.