It’s hard not to pay attention to the news these days, with headlines and news anchors inundating us with the increasingly depressing reality of our economy. After the nasty bank fallout and the tidal wave of foreclosures across the country, many wondered if it could get much worse. Now financial analysts predict credit cards as the next big headache for consumers.
With 2009 bringing even more layoffs to the already-struggling masses, more people will look to loans and credit cards to cushion the economic blow. As we struggle to finance our lives, our credit scores, also known as FICO scores, become essential to that process. These scores are determined by a formulaic calculation of our past debts, how many credit cards we have currently, and other factors in our credit histories. As smart consumers, it’s in our best interest to keep our scores as high as possible—and that means finding out all the unusual ways the FICO formula impacts our lives.
1. Getting Too Close to Credit Limits
Most people know not to max out their credit cards, but even almost maxing out a card is enough to lower our credit scores. Obviously paying it off every month is a positive, but to put ourselves in the excellent credit range (anything above 720 works; the range is from 300 to 850), we should curb our credit card usage, or at least spread it out among a few accounts. Staying within the 25 (ideal) to 35 percent range of our credit limits—and paying off the balance on time—is optimal.
2. Length of Credit History
The FICO formula weighs the payment history most heavily—it makes up 35 percent of our credit scores. (Debt, or amounts owed, comes in second place with 30 percent.) Those who don’t have much of a credit history could be deemed risky by potential lenders and banks, and credit scores are affected negatively as such. However, this ding to the score is only temporary; once an individual establishes a solid record of prompt payments and minimal debts, his or her score will improve.
3. Opening New Accounts (or Trying to Open Too Many)
Those who fear they don’t have enough of a credit history may think it wise to open up a bunch of new accounts, but that’s a bad idea that will lower credit scores. This is considered negative credit behavior. Applying for numerous cards at once is not indicative of a responsible consumer; in fact, it looks suspicious. Even opening up just one new card will negatively affect our credit scores initially because the average account history is lowered as a result. So think long and hard before applying for that department store credit card to get the discount or to enhance credit history. If you need to build up your credit record, get one card that you’ll use regularly and slowly gain a good credit reputation.
4. Too Many Inquiries
When you shop around for loans or apply for various credit cards, companies run checks on your credit history to find out how risky or viable you are as a candidate. All of these inquiries show up on your credit report and, if there are too many, it lowers your credit score. However, this doesn’t mean that you can’t ever apply for loans without being penalized. According to a CNN article, if the credit inquiries are for the same kind of loan—such as for a car or a mortgage—and they are made within the same two-week period, they’re grouped together as one inquiry on our credit reports. Be advised that the rule is not the same for credit cards, so this is another reason not to apply for too many at once.
Speaking of loans, a lower credit score will actually increase the amount of interest paid each month, so even if you do obtain a loan, you’ll end up paying far more than you should. MyFICO.com uses a thirty-six-month auto loan as an example and lists the monthly price for those with poor credit scores at $2,702. People with the highest scores—760 to 850—would pay only $1,736, and even those with average scores still fork over less than $2,000 a month. All the more reason to keep our scores as high as possible.
5. Late Payments and Bankruptcies
The fact that making late payments and declaring bankruptcy lowers one’s credit score should come as no surprise, but did you know that even after rectifying the debt problems, these negatives will stay on your credit report for years? Tardy payments will continue to show up for as long as seven years after the fact and bankruptcies will stay on your report for up to ten years. Incidentally, credit inquiries will stay in our credit histories for two years. Therefore, we should be extremely vigilant about avoiding behavior that results in these problems so that our credit histories don’t haunt our credit presents—and futures.
6. Debt—But in a Good Way!
Many people (me included, before some research) believe that having any sort of debt will automatically lead to a lower credit score. It’s true that a great deal of debt might come off as risky to creditors and lenders, even more so if it continues amassing without any sort of payment attached. However, if you have an understandable amount of debt—a student loan here, a mortgage or car payment there—and you pay the minimum amount owed on time every month, that reflects a consumer who can manage debt responsibly, which will generate a favorable credit score. So owing money isn’t always such a bad thing after all.
As we get older and add to our credit histories, that three-digit number known as our FICO score becomes more and more important. It will affect our ability to get loans, to obtain credit cards, and even how much lenders will require us to pay each month. Taking the time to learn about how these scores are determined and what we can do to raise our assigned numbers will only make getting what we want out of life—a home, transportation, financial security—all the more easy.