The world of credit is a vast, dark cavern of fact and fiction. Once you know
the behaviors that truly benefit your credit scores, you will be on your way toward
The first thing to realize is that credit scores are generated on open and active accounts. Many people believe they should close their credit card accounts to raise their credit scores. This is a complete fallacy. Closing a credit card will never raise anyones credit score; in fact, it is more likely to decrease it.
Balances on Credit Cards
In the credit scoring model, balances on accounts affect 30 percent of the overall score. This is a major factor, almost as important as paying our accounts on time (which is 35 percent of the model). On revolving accounts, the key to keeping your scores as high as possible is to always keep the balances on revolving credit cards under 50 percent of the available line of credit. Going over 50 percent of the available credit, or more importantly, getting close to the limit, will drive the credit scores down. This is the case on individual credit card accounts, but also as an aggregate of all open credit card accounts.
Few people know or apply the concept called credit utilization. Owing the same amount of revolving debt but having fewer overall accounts with available credit could cause a decline in credit scores. Ive heard many people say, Since I dont use this card, I might as well just close it out. This is not wise. Having good credit utilization is good for your score.
Closing accounts removes available credit without necessarily reducing outstanding debt, which could result in raising the credit utilization ratio. If someone had $50,000 in total available credit with $17,500 in outstanding balances, the total credit utilization ratio would be 35 percent, which is fine. Lets say this person closes out two credit cards with $20,000 in available credit but no balances. Now there is a total of $30,000 in available credit, and with the same $17,500 in total credit card balances, the new overall ratio is now at 58 percent. This could result in the credit score going down.
As with Wine, Let Them Age
Longevity is also a key aspect to credit scoring. The age of an account determines 15 percent of the scoring model. The clients I have with credit scores of 800 and over share something in common: they have two to ten credit cards that have been open for over seven years. Credit cards are the one sure way to get there and stay there.
Most installment loans have a much shorter life. Car loans span anywhere from two to six years and will never hit the seven-year mark. Student loans have a greater chance of getting there, but only after you are finished consolidating.
A mortgage may be amortized for thirty years, but the average mortgage is paid off within five years: either the homeowner sells the house or refinances the loan. When you refinance or consolidate, you are paying off the old loan and starting a new one. Therefore, credit cards become your one stable friend in the arena of aging accounts.
Raising Your Score
I am often asked about the quickest way to jump a credit score. There is no magic bullet or single solution, but as I mentioned, watching your balances on revolving debt can have a major impact. Another way is to be added as an authorized user on an existing credit card account.
An authorized user is a person who has been granted permission by a cardholder to use a charge account. The original cardholder is solely responsible for the debt, not the authorized user. The credit card account will show up on the authorized users credit report just like that of the original cardholder. The only difference is that the authorized user account will be indicated by an A coded next to the account on the credit report.
A lender can look at the account and know it is just an authorized account, not an actual debt. In most cases, a lender will not count an authorized account as an open and active trade line when making a lending decision. However, this new history will count in the credit scoring model.
Having yourself added as an authorized user can be a powerful tool, but it is a double-edged sword: if the history of that added credit card is bad, it will give you a bad credit score.
Other Noteworthy Facts
PATRICK RITCHIE is a loan officer and real
estate finance expert. He is author of The Credit Road Map,
a practical guide to navigate the world of credit.