Updated: 7/6/2011 3:53 PM ET|
5 new rules for solid credit scores
Remember those long-standing guidelines like closing old credit card accounts, never maxing out cards and asking for lower interest rates? Well, you can forget them now.
The rules that credit card companies have to live by changed dramatically with the enactment of new regulations in 2010. Now some of the rules for consumers striving to maintain good credit are changing, too.
For the most part, cardholders would still do well to pay on time, keep their balances low and refrain from applying for too many credit cards at once. But some of the old guidelines may not always hold up, as credit card companies continue to adapt to the new environment and look for ways to run their for-profit businesses.
Case in point: Many issuers introduced annual or inactivity fees in the weeks leading to or immediately after the Credit Card Accountability, Responsibility and Disclosure Act went into effect. "Now folks have to decide: Do they want this card badly enough to pay the fee, or do they close it," says Barry Paperno, the consumer-operations manager at Fair Isaac, the company that developed FICO credit scoring.
It's a question of more than just losing a credit line. Closing a credit card can have a big impact on your credit scores. That is, unless you do some groundwork in advance.
With the help of some easy -- if often counterintuitive -- steps, you can improve and retain healthy credit scores even in today's credit environment. Here are five:
1. Open more credit cards
For years, experts warned that opening new credit cards hurts your credit score -- not to mention enabling you to run up huge debts. That's still true: The length of your credit history and new credit make up 15% and 10%, respectively, of FICO scores. But with credit issuers lowering credit limits left and right these days, having too few credit cards puts a much more important credit-score component at risk: credit utilization, or how much of your available credit you're using. Credit utilization makes up 30% of your score.
"More cards mean more available credit and more options if an issuer decides they don't like you," says John Ulzheimer, the president for educational services at Credit.com. Generally, having four or five credit cards is better than having just one or two, he says.
Expanding your credit card portfolio isn't something you should do tomorrow; it's a strategy to be executed over time. If you have just two cards, now is the time to open a third. But wait at least six months to a year before applying for a fourth card.
2. Max out (some of) your credit cards
A quirk of credit score math makes it advantageous to max out certain cards. How? It's a matter of what the issuer tells the credit bureaus.
Some types of cards don't report credit limits to the credit bureaus. They include all charge cards from American Express and some high-end credit cards that are marketed as having no preset spending limit, such Visa Signature and MasterCard World. (These cards have credit limits, but cardholders can exceed them and must pay off the excess in full on the next bill.)
When the FICO scoring system comes across such an account, it will either bypass it for the purpose of calculating credit utilization or substitute the credit limit value with that of the highest balance on record for the account. The most current FICO scores from TransUnion and Equifax bypass charge cards, according to Paperno. So as far as those two bureaus are concerned, your charge card spending will not affect your utilization.
But in cases where the FICO formulas substitute the credit limit value with that of the highest balance, consumers who spend roughly the same amount each month could end up with lower scores than they deserve. The solution: Run up a balance that's much higher than usual. Your utilization ratio will improve in the following months, Ulzheimer says, along with your scores. (Just pay off that balance in full the next month to avoid interest charges.)
Your scores will drop during the month for which your card appears maxed out, so don't execute this strategy if you're shopping for a mortgage or another large loan at the time.
To find out if you have cards that don't report a credit limit, check your credit reports. You can order one free report a year from each of the three credit bureaus on AnnualCreditReport.com. Charge cards are typically reported as "open," while other credit card accounts are reported as "revolving," Paperno says.
3. Don't ask for a lower APR
In the old days, consumers were encouraged to call their credit card companies and ask for lower interest rates. "There really wasn't a downside to doing that," says Gerri Detweiler, an adviser with Credit.com.
"These days, if you call, you may trigger an account review." Should that happen, and the credit issuer not like what it sees, it may cut your credit limit or actually hike your interest rate. This is where having multiple credit cards may come in handy, Detweiler says. "Don't make that call unless you have a backup card where you could transfer that balance."
4. Closed a card? Don't pay it off
Under the old rules, interest-rate hikes applied to both your existing balance and future purchases. Since the Credit CARD Act went to effect, lenders have been limited to applying rate increases only on balances going forward. That said, if you closed an account before the law took effect to opt out of a rate hike - or have closed one since -- you may not want to rush to pay off every last penny of the balance.
In a little-known quirk, FICO counts the credit limits of closed accounts toward utilization ratios only as long as there's a balance on that account.
"You may have a $100 balance on a card with a $10,000 limit, and it's doing wonderful things for utilization," Paperno says. "Once you pay that down, that utilization no longer counts toward your credit score." That means your credit score could take a dip because you paid off the balance.
5. Mix business and personal expenses
Before the passage of the Credit CARD Act, credit experts routinely advised business owners to keep business and personal expenses separate. Use a business credit card for the business and a consumer credit card for other expenses, they advised. Not anymore.
The CARD Act doesn't apply to business credit cards, so using a personal card for your business expenses is safer, says Detweiler.
On the flip side, doing so can easily hurt your credit, especially if your business expenses are high. Even if you pay off your high balances in full each month, they will be listed on your credit report and you could appear overextended. (Of course, there's no guarantee that this isn't happening to you even if you're still keeping things separate. Some issuers now report business credit card accounts to the consumer credit bureaus.) "There's no easy answer here," Detweiler says.
This article was written by Aleksandra Todorova for SmartMoney.
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