If you thought the only thing you had to do to maintain good credit was pay your bills on time, think again. Small, everyday decisions can have a significant impact on your standing.
For years, the credit-card industry was veiled in secrecy (not until 2003 were credit bureaus required to provide a free annual credit report), but now one thing is clear: Doing what’s right for your credit often means doing the opposite of what makes sense.
So, how can you ensure you don’t accidentally do damage? Follow this advice from the pros on what you should and shouldn’t be doing with credit cards.
And, yes, do keep paying those bills on time.Use your credit cards.
Paying in cash and rarely using credit cards may be a point of pride for you, but it isn’t a good move for your credit score. As a result of the credit crisis, companies that once would have left inactive accounts open and tried to lure you back are now quick to close “sock drawer” cards. “Inactive accounts are unprofitable for credit-card companies,” says Liz Pulliam Weston, the author of “Your Credit Score” (FT Press, $19) and a personal-finance columnist for MSN Money.
Although you may not mind losing a seldom-used card, there’s more serious fallout: Because 30 percent of your score is based on your debt-to-credit-limit ratio — the gap between what you owe on all credit cards and your total available credit — having one account closed increases that ratio and thus lowers your score. So, use your cards, Weston says: “Regular, responsible use will help to maintain and improve your score.”
If your card is canceled for nonuse, it’s difficult to get your account reopened. You can try by placing a call to the credit-card company and highlighting your stellar payment history, says Sheri L. Stuart, education manager for Springboard Nonprofit Consumer Credit Management in Riverside, Calif. But you will have to go through the application process again.Pay off the lowest-balance card.
Although paying off the highest-interest card first will save you the most money in the end, the boost you get from quickly knocking out the lowest-balance card may be more instrumental in keeping you on track.
Instead of spreading your monthly payments equally among credit cards, “snowball” your debt, says Lisa Ray, a financial-education specialist at the Consumer Credit Counseling Service of Greater Atlanta. You pay down the lowest-balance card first and pay minimum balances on the rest; as each card is paid off, apply the money you would have paid on it to the next-lowest-balance card and so on.Don’t consolidate credit-card balances on a card with an introductory interest-free period.
“Balance transfers can work in your favor if the interest you save outweighs the transfer fees,” says Leslie McFadden, a credit columnist for Bankrate.com. Otherwise, when the low introductory rate goes up, possibly to more than that of the card from which you’re transferring the debt, you may end up paying more interest than you would have on the original card. Also, “you have to be careful that you’re not running up so much of the new card’s credit limit that it’s hurting your score,” McFadden says. Consolidating multiple balances on a lower-limit card can make it look to the credit bureau as if you’re close to maxing out that second card (using most of your available credit limit), which is frowned upon.Pay annual fees on a rewards card.
There are plenty of rewards cards out there that don’t charge annual fees, but paying one can make sense. In the end, a card with a fee and good benefits that suit your lifestyle may save you much more than a no-fee card you’ll use less. In weighing a card’s merits, try to project which benefits you’re more likely to use in a year. If the rewards (free hotel nights, discounted movie tickets, cash back into your child’s college savings account) total more than the card’s annual cost — and more than what you would save with a no-fee card — it’s worth the expense.Don’t close cards once they are paid off.
Fifteen percent of your score is determined by the length of time you’ve had credit. By closing your oldest account, you can shorten the length of your credit history, which can deal a blow to that part of the formula.Don’t max out one card, then pay the full balance every month.
You don’t get any points on your credit score for paying off the balance. In fact, credit bureaus don’t even consider it. More important, maxing out one card, even if you never carry a balance or pay interest, raises your debt-to-credit-limit ratio. Bureaus consider individual cards’ ratios, as well as your total ratio. For example, if you charge $4,000 of your $5,000 limit, you’re using 80 percent of your available credit. “Keep balances as low as possible,” McFadden says. “Using less than 30 percent of your credit limit is a good goal.”Don’t open retail-card accounts.
Twenty percent off a new pair of jeans isn’t worth the potential damage that opening a store card can do to your credit score. First, five points are deducted for each new retail or gas card. Second, you’re lowering the average age of your credit history. Third, these cards tend to have lower limits and higher interest rates — sometimes 20 percent or more. Finally, running up balances on low-limit store cards affects your credit score more negatively than using one or two bank cards because bank cards’ higher credit limits increase your debt-to-credit-limit ratio.Don’t pay off credit-card debt with a secured loan, such as a home-equity line of credit.
Doing so may seem like a good idea because the interest rate can be lower and you can consolidate your debts and make just one monthly payment instead of monitoring several cards. But by rolling credit-card balances into a home-equity loan, you are essentially converting unsecured debt into secured debt, Ray says. You’ll be putting your house up as collateral for the new television set or laptop that you charged. And if you can’t make your payments for any reason, debt collectors can seize your property.