Clearly, we are a nation that loves credit.
Many people collect credit cards like some collect Beanie Babies. The average household now carries about $9,000 in credit card debt.
But here’s something you should understand if you have a credit card. Credit is a game and you had better know the rules. If you’re going to use credit cards, you need to manage them to maximize your credit score, which is your credit history grade that is used by lenders to determine if they’re going to give you more credit and at what cost.
For example, do you know if having a lot of available (unused) credit makes you look risky to lenders? Would your credit look better if you closed those accounts? If you recently missed a payment on an old account, will it disappear from your file if you close the account?
For the first time (because I kept bugging them), Fair Isaac Corp., the company that created the FICO credit score model used by the major credit bureaus, has put together guidelines to further explain how credit card accounts affect your credit score.
To begin, you should know that credit scores take into account the following factors when it comes your credit cards:
Now let’s look at what other factors can boost or reduce your credit score. Fair Isaac provided the following information to the most frequently asked questions I get from readers:
Do closed accounts stay on my credit report? They sure do. A card’s account history is not immediately deleted from your credit report after you close the account. It will continue to be considered by the FICO score in some of the ways listed above as long as it appears on your credit file. How long is that? Under federal law, credit bureaus must remove negative records from your credit report after seven years. However, the bureaus may keep positive records on your report longer than that.
Does reducing my available credit improve my credit score? You might have heard that having a lot of available (unused) credit is regarded by lenders as risky, and will lower your score. This is not true for the scoring models produced by Fair Isaac. Available credit by itself is not considered by the FICO score, because it is not nearly as predictive of future repayment risk as how you have managed your actual debt.
Can unused credit accounts help my score? Generally speaking, the lower your balance compared to your maximum credit limit, the lower your risk of missing payments in the future and the better your credit score will be. So having credit accounts with very low or no balances will often improve your score.
Should I close unused credit cards? You typically won’t gain anything by closing unused credit card accounts. In fact, closing credit accounts can sometimes result in a dip in your score. For example, you shouldn’t close accounts shortly before applying for a new loan since that could lower your score and hurt your chances for a good interest rate. But you may want to close credit card accounts for other reasons. For instance, you may feel that having spare credit cards will tempt you to overspend and get you into financial trouble. Also, the fewer cards you have, the less likely you will miss fraudulent charges by some crook.
Finally, here are some tips to help you decide which accounts to close and which ones to keep.
Close credit card accounts that have lower credit limits. Why? A balance on a higher limit card will be treated more favorably by the FICO score than the same balance on a lower limit card.
If you’re going to close accounts, cancel retail cards before bank-issued cards. Bank cards include your Visa, MasterCard, American Express or Discover card. Retail cards include department store cards and specialty store cards. Since bank cards are tougher to qualify for, can be used in more places and usually have higher limits, they offer you more opportunity to manage your credit well (or poorly). Therefore, they typically have a bigger impact on your score.
Keep your older card accounts open. The longer you demonstrate you can manage credit responsibly, the better your score will likely be. That’s why you want to keep your older cards active if you can.
Leave at least one card account open. Research shows that consumers who use credit card accounts moderately — by charging low balances and repaying them on time — have slightly better repayment risk than consumers who do not use revolving credit at all.
But let me leave you with this last tip from Thomas Jefferson, who had his own problems with debt: "Our business is to have great credit and to use it little."
(c) Washington Post Writers Group
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