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7/24/07

Credit Score Conundrums

In my previous post, What are the Components of a FICO Score?, I discussed what the Fair Isaac Corporation takes into account, and each items respective weight, when calculating your FICO score. The interesting thing that I have noticed is that certain practices can both raise and lower your credit score. Lets look at a few of them:

(1) 30% of your score is based upon you debt to credit ratio, while 10% of your score is based upon the number of credit inquiries and “new” credit. The ideal situation is having a maximum of 25% of your credit in use as compared to your debt. Therefore, if you have $1000 in credit, you want to owe no more than $250 total.

As you continue to make consistent payments on your cards, you will most likely become eligible for a credit limit increase. However, you usually have to ask the credit granting company for an increase on your limit. This is good because it will lower your debt to credit ratio, however, you have just created “new” credit and just had an inquiry dinged against your credit report, and thus could lower your score. Interesting!

(2) Some experts state that you should pay off your outstanding balance in full while other experts say that creditors want to see consistent payments, thus you should always pay your bill over time. We now know that 35% of your FICO score depends upon timely payments. Nowhere in that calculation does the amount paid come into affect. Creditors send you a bill with the minimum payment set for you. Most experts agree that you should more than the minimum payment, but not for credit score reasons. You should make more than minimum payments so that you do not get hosed by the interest charges.

The bottom line is, paying off your amount due, whether in full or in parts, is not going to hurt your score (as long as those payments are timely). If you can afford to pay more than the minimum payment, do it. If you cannot, do not. I seriously doubt a creditor is going to penalize you (by means of a lower credit score) for paying back their money in one lump sum!

(3) 10% of your score is based on the type of credit you have. Most people build their credit score in order to take out installment loans, however, installment loans can lower your score. The situation that presents itself is an odd one. Most people build their credit score in order to purchase a car and/or home. However, taking out one of these loans can lower your score because some creditors may feel that this big monthly obligation could affect your ability to pay them back. Now we are back to the debt to credit ratio and the choice of whether or not to raise the credit limits.

The truth is, it seems that certain simple strategies (pay your bills on time, keep your debt low, and keep your credit high) have been to proven to build a credit score significantly. All of the other little things can either slightly chip away or slightly add to your credit score. As I pointed out, some strategies can have both a positive and negative effect. Therefore, if you want to play it safe, stick to the simple strategies and always be aware of the contents of your credit report and credit score.


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