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Your FICO score

FICO scoring has never been more important, as banks are now taking the risk of lending money a bit more seriously. Let’s review, as best we can, how this score is determined and what you can do to improve your score.

FICO chart

By the way, the above is from a PBS special, “Secret History of the Credit Card.” Mrs. Taxpayer is still kidding me how a show with such a title can get my interest.

FICO formulas are still a bit of a secret, but the above is a good start. As I’ve read more about each of these criteria, I understand that ‘amounts owed’ are a ‘percent available credit used’ more than total dollars. So accepting a new card and instantly using the entire line may have a bit of an impact, but this is where unused credit on other cards actually helps bring down the total percent used. Of course, applying for too many cards in a short timespan also will impact your score.

Canceling cards can hurt you in two ways, raising the ‘percent credit used’, and reducing average age of accounts, so these are concerns. It may be a great feeling to cut up your paid off cards, but the better choice may be to check your score and act slowly. Keep the cards that have no annual fees, making a small charge now and then. If you plan to cancel the cards with fees, first calculate the total percent credit used, so you are sure that canceling those cards don’t impact your score. In the long run, paying one more annual fee may save you by avoiding the rate bump you may see from a lowered score.

If you are in dire straights, still make every minimum payment. Even if this means charging the same amount you just paid off. Missed payments will quickly impact the interest rates on the card involved, and soon raise the rates on all your open accounts.

There are those (such as Dave Ramsey) who will tell you to avoid all credit cards. This is nonsense. Graduate college, get a good job, save for a house, and you’ll find that without any credit history your options to get a mortgage will be limited despite the nice downpayment and low debt to income that new mortgage would cost you. Instead, find two no-fee (you’ll pay in full so the rate doesn’t much matter) cards, with a rebate or some perk, and use them for your routine purchases, even just gas if you wish. This will help build a real credit file and keep you from being financially invisible.

Last, check both your Credit Report as well as your credit score on a regular basis. Annual Credit Report will link you to your choice of reports from the three major credit reporting agencies for a free report once per year. By cycling through them, you can use a different one every 4 months, and catch errors or suspect activity a bit faster. Credit Karma is a great way to get a FICO score for free on a regular basis. Neither of these companies will ask you for payment or to sign up for a paid service as a condition of the free reports.

  • Augustine July 27, 2009, 11:57 am

    Since the credit card companies are having second thoughts, we’re seeing unused cards canceled and limits reduced. Such actions have the potential to affect the history and debt ratio, or 45% of the credit score. And that without one doing anything on one’s part.

  • The BoBo July 28, 2009, 11:19 pm

    Interestingly, I have no FICO score. Haven’t had one in about 1 year ever since I paid off all my debt, cut up my cards, and pay everything with cash now. While I think your post is very informative, it would serve everyone better to get out of debt and not worry about FICO. If you can’t pay for it, you can’t afford it.

    You’d be surprised at how many businesses out there prefer to deal with cash customers. You can actually negotiate the price on many items when its cash. You don’t get that luxury when you put it on a card or apply for store credit. I just bought a washer/dryer at Sears that had a floor price of $2,500 (we went for the HE appliances) – once I started flashing the cash – we got them for $1,800. As long as you know the art of negotiation, have cash, and no debt – you don’t need to worry about credit or FICO to get what you want.

    BTW – I am a graduate of the Dave Ramsey Financial Peace University. He’s right. You don’t need credit or credit cards.

  • JOE July 28, 2009, 11:39 pm

    BoBo – I hear you. One question for the Dave students – how do you get a mortgage? And what kind of rate do you get?

  • Eli July 29, 2009, 3:36 am

    Very informative post as it gives an in-depth discussion on credit cards and rating/score, etc. I still believe having a credit card is better than none at all, for two reasons: 1. it gives you the convenience and allows you not to carry huge amount of cash, thus preventing hold-ups and robbery, and 2. it provides “cash” when you do not have cash for emergency purchases. As to worrying about paying the credit, it is a manner of fiscal discipline and budgeting.

  • JOE June 21, 2012, 12:35 pm

    How’s this? I agree that for those who have shown themselves to be irresponsible, avoiding cards is a good idea. A baby step toward responsibility is to use one card, and use it only for gas. Why gas? Because I view it as a need, and even one with poor self control can manage to pull up to the pump get gas, and go home to put the $40 in an envelop to pay the bill when it comes in.
    In the current economy, I mean the day to day way our system works, zero card use is an outlier. If you wish to keep one card on ice, but take it on a trip to rent a car and hotel room, I take no issue. Last time I tried to put a room on a debit card at check-in I was refused. I did that just as an experiment, I had credit cards at the ready.

    Who has $100K in the bank when they go to buy a $125K house? But I agree, a local bank might approve you under that scenario, I don’t know for sure.

  • Warren June 21, 2012, 11:39 am

    With regards to “Dave students” – the advocacy of eliminating all credit cards is directly related to living within your means and not using them if you’ve gotten into trouble in the past: not that having them at all is a Bad Thing (or, at least, so I understood when doing the class).

    Another focus is to save as much as you can and use your personal assets as your credit worthiness report: if you have, say, $100 000 saved, and the house you want is $125 000, then when you go to the bank (preferably one that knows you well already), they can see your frugality and good budgeting, and you get a good mortgage.

    Of course, having a credit score outside of just that is awesome – and useful if you want to use a bank (or credit union) which is new to you.

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