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August 2013

Don’t Wreck Your Credit Score


Readers of “consumer Checkpoint often ask me about credit scores and whether something like closing an unused credit card will improve their credit score, particularly in these days of relatively tight credit. CUNA Mutual, an insurance and retirement planning cooperative for credit unions headquartered in Madison, recently published a list of actions consumers should avoid. Your credit score is important because it determines your eligibility and what you may pay for loans and credit cards. For example, while mortgage interest rates are near historic lows, many consumers do not qualify for mortgages because of poor credit scores.

Most consumers will easily understand the first few recommendations.

First, pay your credit card bill on time. An occasional missed payment date likely won’t greatly impact you, but never get into the habit of letting dues dates slide because this may cost you greatly.

Second, failing to pay your credit card bill at all will significantly damage your credit score.

Third, avoid the temptation to spend your credit cards to the limit because credit-scoring companies such as Fair Isaac in Minneapolis calculate a “utilization score” based on the amount of available credit you actually use. Consumer advocates recommend you keep your credit card use to less than 25 percent of your credit limit. This means that if you have three credit cards with a total credit limit of $10,000, you will want to keep your total credit card usage to less than $2,500 each month. If you use a credit card for business expenses, this could be a difficult number to manage. You need to balance the potential credit-score harm against benefits you might receive—such as cash back or frequent-flyer miles. Please note your payment history, along with your total debt, accounts for two-thirds of your credit score.  

Fourth, and less obvious, you lose credit-score points when closing old credit cards or cards with existing balances. Yes, this may seem a bit odd and I admit that my wife and I used to think it was a very good idea to close unused credit cards. However, as we later learned when we applied for a home mortgage, our credit-history length counts for 15 percent of our credit score and, by closing credit card accounts, we reduced that important history. Moreover, closing a credit card carrying a balance will harm your credit utilization because you are reducing your overall credit limit while, at the same time, increasing the percentage of credit usage.     

Fifth, if you apply for a number of new credit cards at one time, lenders reading your credit scores may become suspicious. They could think you might be in financial trouble and are making charges you may not be able to later pay. However, please note that Fair Isaac and other credit-scoring companies make an allowance for when you, or someone on your behalf, is making multiple credit inquiries at one time for such things as buying a car. 

Finally, lenders want to lend to consumers with reportable credit history. If you are someone—like many from my parents’ generation—who does not like to borrow money at all, the lack of reportable credit may be a handicap because new credit and credit mix are 10 percent of your credit score.

The key to obtaining credit in this economy is to maintain a strong credit score.      



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