Credit Cards
Even if you pay your bills on time, how you use your credit cards can influence the cost of your next loan.

Credit scores (of which FICO scores are a subset) have always been important because banks and financial institutions use them to determine individuals’ credit worthiness. However, with lending institutions raising their standards in light of this past credit crisis, your score is more important than ever.

Overall, this tightening of the purse strings is a good development for the industry, but it also means some individuals may be unfairly punished for otherwise responsible behavior. While borrowers who are late or miss payments take a justifiable hit to their credit scores, those who always pay on time may still have their scores dinged.

What is a Credit Score?

Your credit score is your financial reputation. Just as your personal reputation influences how others in your community treat you, your credit score impacts the willingness of financial institutions to extend you credit or lend you money. This can mean the difference between being limited to small, expensive lines of credit (or being denied completely) and getting substantial loans at market rates.

What Makes for a Good Credit Score?

The biggest factor in determining your credit score is perhaps the most obvious one, your repayment history. Taking out credit and repaying it on time is good for your credit score. Being late with your payments or missing them all together is bad. Other factors, however, are far less obvious and sometimes fly in the face of conventional wisdom.

A variety of credit is best. Having a mix of credit between student loans, car loans, credit cards (not more than four is recommended), and mortgages will generally improve your score. It’s not necessarily advisable to take out a loan specifically for the sake of establishing a good credit score, but everyone should be aware that shunning some forms of credit completely (such as credit cards) can be detrimental in the long run.

Checking your credit history is your responsibility. There are three credit bureaus that track your credit history, the record that determines your credit score. Sometimes, these bureaus can make mistakes that affect your score, and when they do, they have no financial or legal obligation to correct the errors until you point them out. The burden is therefore on you to check your own record, which you can do free once a year at www.annualcreditreport.com (the only free, government-approved website for doing this).  For a modest fee, you can also subscribe to a service such as this or this to receive email alerts whenever there is any activity on your credit report. This can be a helpful strategy to immediately catch errors or identity theft.

A credit card balance above 30% of your combined limit is detrimental. It’s not well known, but the balances you keep on your credit cards relative to your combined credit limit affects your score. For example, if you have two credit cards, each with a credit limit of $5,000, you may begin harming your credit score when you charge over $3,000 between the two of them (30% of $10,000) in one period. This is true even if you pay the balance down completely at the end of the month. To avoid this, watch your balances, and if you are getting close, request that your credit card companies increase your credit limits if possible.

Cancelling old credit cards is not always advisable. Although it may be a small hassle, keeping your older credit cards open may be good for your credit score. This is because part of your credit score is determined by the length of time you’ve had certain credit lines. Canceling a credit card removes that credit line from your financial history. If you no longer use them, keep older cards in a safe place since periodic purchases (usually a few times a year) may be necessary to prevent the account from being cancelled by the provider. Refer to this article for more information on how and when to cancel credit cards.

Even opening a bank account may hurt your credit score. When you apply for a new loan, a credit card, or even certain bank accounts, an action by the financial institution called a hard pull is performed to verify your credit. This slightly lowers your score for exactly six months. If you are planning to apply for a mortgage in the near future, avoid applying for new financial products that will result in hard pulls. You may need to ask your bank about their specific policies. Also, be sure to say “no” when the checkout clerk offers you a discount if you apply for their store credit card. A few dollars saved in a retail store may cost you substantially more on your home mortgage.

In Conclusion

If you’re curious about your own credit score, you can either use this free credit score estimator to get a ballpark figure or pay to get your exact score from myFICO.com. Just be careful when signing up for any reoccurring plans unless you’re certain you want them.

The good news is that following the above guidelines may potentially save you thousands of dollars on your next mortgage. If you are thinking of buying a new home or refinancing your current home, you might want to start by giving your lender a call. A savvy lender will pull your credit report and counsel you on specific strategies to improve your credit score. But don’t wait until the last minute to make that call. Getting errors to your credit corrected is a big hassle and can take weeks and even months to get resolved.

If you have specific questions about getting a home loan (or buying a home to go with it), feel free to call me at (312) 440-7525 or email jenny@jenniferames.com.


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  • Thanks for the great information