These days, your credit history and credit score are the center of your financial life.
Your credit score governs whether you can get a mortgage, home equity loan or line of credit and how much you’ll pay for that mortgage.
Your credit score also governs whether a company will insure you and how much you’ll pay as your premium.
And, many employers will pull a copy of your credit history before making you an offer for employment. If your credit history is tarnished, you might find job offers evaporating.
The three credit reporting bureaus, Experian, Equifax, and Transunion, along with Fair Isaac, the company that invented the credit score, take the information in your credit history and run it through a mathematical formula that takes the pieces of your credit history and turns it into your credit score.
The higher the credit score, the less of a credit risk you’re perceived to be.
There are a number of established rules for building a good credit history and keeping your credit score high, including:
1. Pay all of your bills on time, and if possible, in full. If you can’t manage to pay off the amount you charge each month, you should at least pay the entire minimum payment owed. While you’ll pay interest on the remaining balance, at least you won’t incur any additional fees and you won’t hurt your credit score as much. There are times that only paying the minimum amount due, depending on other circumstances, may harm your credit history.
2. Don’t run too big a balance. Creditors look at the relationship between your available credit and how much of that total credit you’ve used, which is called the “utilization rate.” Ideally, you shouldn’t use more than 35 to 30 percent of your total available credit. That means if your credit card limit is $3,000, your outstanding charges on that card should never exceed about $1,000.
3. Keep your accounts open and in good standing for a long period of time. Never cancel a credit card you’ve had for more than 10 years. Longevity is one of the important keys to a solid credit history. If you feel the need to change credit cards, find out if you can convert your current credit card to the one you would want. For example, if you want a credit card that gives you points for your purchases and don’t have one, see if your credit card company offers a card that gives points and if you can switch over to that card without closing your account.
4. Open a variety of different credit accounts. Credit industry insiders tell me that having four open and active lines of credit is helpful to your credit score. All the better if you have a mix of different types of credit, such as credit cards, home loan, home equity loan or line of credit, auto loan or school loans. Just keep in mind that if you have too many cards and have a high credit limit on all of them, the combination of the number of cards and the amount of credit extended to you can cause a reduction in your credit score.
5. But don’t go into debt just to boost your credit history. There’s no need to add to your debt load in order to strengthen your credit history. Opening up another credit card account, as long as you just pay off your balance in full each month.
6. Never close a credit card account without paying off the balance owed in full. Canceling an account with a balance on it tells creditors you can’t manage your finances effectively – even if it was your choice to close the account. Keep your account open and active, even after you pay off your existing balance in order to keep your credit score as high as possible.
Now that the CARD Act has gone into effect, creditors have had to change the way they deal with consumers. And as Ken Lin, CEO of Credit Karma notes recently, there are some new rules for keeping your credit score as high as possible.
First, don’t call your credit card company and ask for a lower annual percentage rate (APR) for your credit card. Today, Lin says, this request could spur an account review, and you could wind up with a lower credit limit or an interest rate hike.
If you carry a balance, a lower credit limit would mean that your balance would be a bigger portion of your total available credit. That alone will negatively impact your credit history and score.
Second, if you do close a credit account that has a balance, take your time in paying off that balance. Due to the CARD Act, Lin says that if you opt out of an APR hike by closing an account, creditors cannot apply a higher APR to the remaining balance. Plus, as long as you’re paying off the card, that credit limit will count toward your credit utilization ratio for your credit score.
Finally, some credit card companies are lowering their card holders’ credit limit as a balance is being paid off, which doesn’t help improve your utilization rate. If that happens, Lin suggests opening up another credit card account in order to improve your overall utilization rate.