How well do you know the current landscape for improving your credit score?
By Tom McDavitt
A friend of mine, who is a very successful business owner, was recently declined for a travel rewards credit card. While discussing this, I realized that he was playing the credit score game by the “old rules.” Many people don’t understand the way credit scores work these days. There are two major components of your score and three other factors that have a lesser impact. Thirty-five percent of your score comes from your payment history; 30 percent from the amounts that you owe; 15 percent is from the length of your credit history; and 10 percent is factored from the types of credit used and the new credit activity you display. FICO scores range from 300 to 850.
It still is very important to pay your creditors on time. This includes all types of loans such as mortgages, auto loans and credit cards. One or two late payments won’t have much of a negative impact, but you’ll have a hard time reaching the much-coveted 800 level. Believe it or not, the more accounts that you have, the less impact a late payment will have. Most people mistakenly believe that too many accounts are a negative, but the opposite is actually true. FICO looks at the percentage of debt paid on time, so if you have three accounts and are late on one, you are tardy on 1/3 (33 percent) of your accounts. If you have 10 active accounts and are late on one, then you are only out of favor 10 percent of the time!
This is often called your “utilization rate.” FICO tabulates the total amount of debt you have available to you versus the balance that you have outstanding. My friend didn’t have a mortgage or car payment and only carried a few credit cards with modest credit lines. He paid his balance each month, but he would tally a balance equal to 50 percent to 75 percent of his available credit line each month in order to get rewards points. As a result, he had a very high utilization rate, which undoubtedly hurt his FICO score. One simple solution is to call and ask the existing cards for a credit line increase. Most of the time, they will oblige and your utilization rate will improve in a few months. Even though he is very unlikely to use the increased credit line anytime soon, it is still better to have it and not need it versus needing it and not having it. Furthermore, it is not a good idea to “cut up old cards and close the accounts.” Lastly, if you get offered a credit line increase, you should accept it in most instances.
Length of credit history
Your score improves when you show a long history of solid credit, so if you close that old account that didn’t have any more use in your current activity, you hurt your score. If you have a credit card that you have had for many years, keep it, and you will score higher. For example, I pay a single modest bill every month with my oldest card to keep it active.
Please be aware that having too many cards can be difficult to keep track of and therefore, more likely to lead to late payments. You should monitor them carefully or set up automatic payments by the due date. Most cards allow you to pay your balance on the due date by triggering their “autopay” feature, which will prevent any problems, as well.
One way of hurting your score is to have an unusual number of credit inquiries in a short period. Be careful not to run out and apply for several cards right away after you read this article! Too many credit checks in a short span can make creditors suspicious that you are trying to acquire large amounts of credit that you plan to borrow against and then can’t pay back. You are best to spread your new applications out over time, while continuing to show a positive payment history.
You should always avoid using a debt negotiation company. They might help you reduce your monthly payment or even reduce your balance due, but they will also do long-term damage to your FICO score. If you run into financial difficulties, call the credit card right away and explain your issues. Most will work out a solution with you if you have been a solid citizen with them for an extended period.
There are many resources available today on the subject. Some great resources include AnnualCreditReport.com and MyFICO.com.
Tom McDavitt, located at 181 Main St., Suite 20,0 Shrewsbury, MA 01545, is a Registered Representative and Investment Adviser Representative with/and offers Securities and Advisory Services through Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at (508) 842-6222. For residents of AZ, CA, CT, FL, GA, IA, MA, ME, NH, NY, PA, SC, and VA.