Managing your credit in these challenging economic times.

Not long ago managing your credit was a hot topic. Everyone wanted access to the easy money floating around and there was plenty of advice on how to build and maintain a good credit rating. Suddenly those voices have gone silent, but now more than ever it’s critical to keep an eye on your credit ratings.

These days it seems most lending institutions have gone out of the lending business, making credit pretty hard to find even for the most credit worthy. This will eventually change and the credit markets will return – don’t ask me when – but they will. But when the worst is past and the banks are lending again the requirements will be much stricter than they’ve been for most of the past decade, and your good credit score will be key. While the math behind the credit score is complex and mysterious (my statistican wife claimed it’s a State Secret,) in general there are five key factors to be aware of:

How Fair Isaac Corp. weights the various parts of your credit management to determine your credit score.

1. Payment History

It may seem obvious but paying your bills on time is the most important thing you can do. If you’re behind on a credit account make it your financial priority to get current and stay current. While this is important on all your accounts certain types of credit will impact your score more. Always try to pay your mortgage first and then your credit cards.

2. Watch your utilization rate.

Your utilization rate is the total amount you owe divided by your credit available. So if you have a credit card with a $5,000 credit limit and a $2,500 balance, your utilization rate is 50%. Credit bureaus generally like to see utilization rates in the 30%-35% range. This is less an issue of what you owe than how you manage it. For example, do not close an established credit account as a short term strategy to improve your score. Here’s why…

Suppose you have 4 credit cards with $30,000 of total credit available, and on average you carry a total balance of $9,000. Your utilization rate is 30% and everybody is happy. Now you decide to cancel a card you never use, with $0 balance and $10,000 of credit available. All of a sudden your utilization rate is 50% and your score could take a big hit.

I know the schemers among you are thinking “I’ll just run out and apply for a bunch of new credit to drive down my utilization rate.” Unfortunatley they’re on to you because…

3. Length of Credit History.

Longer credit histories are more heaviliy weighted than new ones. So if you’re going to cancel a card try to cancel a newer one. New credit accounts will reduce your average account age, and that can result in a lower score.

4. Type of Credit.

Mortgages and HELOCs tend to have the strongest impact on your credit score, followed by credit cards. If you’re going to close down a credit account close your department store cards first. (In fact, better would be not to get sucked into those one-time 10% discounts to open new revolving credit account.) Then consider your newer bank cards such as Visa or Mastercard. But try to avoid the shell game of moving balances around. If you really want to stop using a card, pay it off first then shred the card.

5. New Credit

If you’re looking for new credit – maybe a mortgage or a new card – be focused and do your inquiries over a short period of time. The scoring systems will track the length of time over which new credit is sought and distinguish between the search for a new line of credit from trying to open a bunch of new credit accounts. Many commercial inquiries into your credit score over time can really pull down your score. But remember, checking your own credit report will never affect your score, and this is something you should do regularly.

6. Expanded Use of Credit Scoring

If everything we’ve said so far seem old news to you, this last one may be a bit of a surprise; more and more institutions are using, or contemplating using, your credit score to evaluate you as a customer. Insurance is a big one. It’s controversial still but be prepared, it’s coming. If you have a bad credit score you very likely will not only pay more for your mortgage but you’ll pay more for insurance as well (if you can get either.) There is talk about credit scores being used in evaluating job applicants as well. For now the major reporting agencies claim they do not make credit scores available for employment evaluations, but a growing population of employers claim they do look at a person’s credit history. Whatever the truth, a well managed credit history is becoming ever more important in our modern world.