I’ve heard from more than a dozen readers who were confused by a recent column on how to clean up your credit history (also known as a credit report) and credit score.
So, let’s clear the air.
First, your credit history also includes personal factual information, such as your name, Social Security number, current address, how long you’ve lived at your current address, and past addresses.
Your credit history is primarily a list of all of the financial activity in your life. It lists all of the credit accounts you have ever opened, and how long they’ve been opened, including credit cards, a mortgage, home equity loan, student loans, car loans, personal loans (provided that those were reported to the credit reporting bureaus), lay-aways, and any other type of credit or lending account you might have.
In addition to listing each of these credit accounts, your current balance, and your highest balance, your credit history provides information on your payment history. If you’ve made every payment on time for as long as you’ve held the account, your credit history will note that fact. If you’ve missed a payment or two, it will list how late you were and whether the account is current or you are behind in your payments.
Your credit history will also include any charge-offs–an amount you owed that the creditor has decided you’ll never pay, so the company has charged-off the amount as a loss, and likely sold it to a collection agency, tax liens, court judgments, and overdue child support.
Negative information like this will stay on your credit history for up to 10 years. Late payments will stay on your credit history for up to two years, but like all negative information, it will affect your score less as time marches on.
And finally, your credit history also lists “inquiries.” Every time a prospective lender, creditor, landlord, insurer, or employer pulls a copy of your credit history to see how it looks, it’s called an “inquiry.”
Your credit score is a number from 300 to 850 (on the Fair Isaac FICO scale, which is the credit score most often used by mortgage lenders). The number is calculated by assigning a value to each piece of your credit history. The numbers are crunched together, with different pieces of your credit history assigned a different weighting.
For example, your payment history is worth 35 percent of your total score. That’s why a late payment or two can dramatically lower your credit score. The amount you owe is worth 30 percent of your score, which is why if you borrow up to the maximum limit on your credit cards it will lower your score.
How you manage new credit is worth 10 percent of your score, and how many different types of credit used is also worth 10 percent of your score. So, you’ll have a higher score if you have a mortgage, credit cards, and a car loan than if you just have a mortgage. However, don’t take out more debt just to have more accounts. Just having accounts open, but without balances, can help.
How long you’ve owned your credit accounts is worth 15 percent of your total score. This is the point that seems to be most confusing to readers who are concerned about canceling a credit card.
I’ve had two credit cards for a long time, 18 years for one and 21 years for the other. I don’t pay anything to carry them, and I still use the accounts, paying off the balance in full at the end of the month.
I have a very high credit score, but if I were to cancel one or both of these cards, my credit score might take a serious hit. Why? I’ve closed the two accounts that represent a significant piece of my credit history. While I may have closed the accounts for valid reasons, the number-crunching formula that creates a credit score might assume that I’ve closed them for a negative reason.
Because so much of your score is based on how you manage credit accounts, closing an account that has been opened a long time (more than 5 to 10 years), might damage your score.
What if you’ve only had a credit card for a year or two? If you have other credit card accounts, and you want to close a new one, go ahead. Closing a newly-opened card won’t hurt you that much.
But think about that carefully. If you’re not paying any annual fees on the cards, and you’re not carrying a balance on the account, the APR that is charged doesn’t matter. You’re just accumulating credit through the years, which will ultimately help your score. I have a wallet full of credit cards. Most of them don’t get used each month, and I don’t pay annual fees, but they contribute to my high credit score.
The biggest mistake that consumers make (and it’s a doozy) is closing a credit account that has a balance on it. If you have a balance on a card, try to avoid closing the account or your credit score will take a big hit.
Errors are rife on credit histories, so it pays to check yours out. Go to AnnualCreditReport.com, which is the only site sponsored by the three major credit reporting bureaus, Experian, Equifax, and TransUnion. You can pull a copy of your credit history from each of these credit reporting bureaus once a year. If you have mistakes, you have the right under Federal law to contest them.