… even if you pay your bills in full each month

Many would-be borrowers are discovering that their good credit scores are no longer good enough. That’s because lenders and credit card issuers have become increasingly cautious as more borrowers default on their loans and fall behind on credit card payments.

Just two years ago, most of the best mortgage and credit card deals were available to anyone with a credit score of 700 (out of a maximum of 850).* Today, borrowers must have scores of at least 720 — and often as high as 750 — to qualify for the most appealing mortgage and credit card rates. Terms on auto loans also become less attractive for people with scores below 750.

Surprisingly, only about one-third of the formula that makes up your credit score reflects whether you pay bills on time. The often-overlooked details that affect the remaining two-thirds could make or break your next credit application.

How to avoid hurting your score…

  • Use only a small percentage of your available credit. The percentage of available credit that a cardholder uses determines roughly one-third of his/her credit score, making it just as important as paying bills on time.

    Example: If you have just two credit cards, each with a $2,000 credit limit, and a total balance of $3,000 on these cards, your credit utilization percentage is $3,000 divided by $4,000, or 75% of your limit. (Only credit cards are included in this calculation, not home-equity lines of credit.)

    A credit utilization percentage below 10% will earn you the maximum number of points in this component of your credit score. Above 10%, there is a sliding scale, and your credit score will suffer greatly if you come anywhere close to maxing out your cards. In determining this portion of the score, credit bureaus do not take into consideration whether you pay off balances in full every month or carry rotating balances.

    What to do: Pay off your credit cards completely, and don’t use them during the 60 days prior to submitting a loan or credit card application. Ask your credit card issuers to increase your credit limits, but do so only if you have the discipline to avoid using this extra credit.

  • Limit credit applications. Just applying for any type of credit can damage your credit score. Approximately 10% of your overall score is based on the number of credit applications you have made during the past 12 months. (Credit applications include everything from credit card and store card applications to auto and mortgage loan applications.) If you have a limited or troubled credit history, even two or three credit applications make a significant difference. If you have a solid credit history, a few credit applications over the course of one year will not have a substantial impact, but a large number might.

    What to do: If your credit history is less than stellar, do not apply for credit cards that you don’t really need, including cards at retail stores that you get mainly because they offer a 10% or 15% discount on your purchases for a limited period of time. This is particularly important if you are about to submit a loan application, such as for a car loan or a mortgage. Ask your current card issuers to match competitors’ terms, rather than jump from one credit card to another in search of more attractive rates. Postpone filling out applications for anything that triggers a credit check — say, for a lease on a new apartment or a new cell-phone plan — until after you have received approval on an important loan.

  • Diversify your credit. As much as 10% of your total credit score is determined by how many different types of credit you have now and have had in the past — the more types, the better. Types of credit include credit cards, retail cards, gas cards, auto loans, home loans, student loans and personal loans. It is particularly important to have had both major bank credit cards (or retail or gas cards) and installment debt, such as auto loans or mortgages, on your credit history, even if these accounts are unused or have been paid off.

    What to do: It does not make sense to take out a loan or open a credit card account just to earn these credit score diversity points. However, if you already are considering establishing credit of a type that you never used before (such as an auto loan) instead of paying cash, realize that it may help your credit score.

  • Hang on to old cards. Approximately 15% of your credit score is determined by the age of your oldest credit accounts — the older, the better.

    What to do: Do not close your oldest credit card accounts, even if you don’t use them much now. If you do not have any long-term credit accounts, ask a parent, spouse, sibling or someone else close to you to add you to his/her longest-standing credit card account as an “authorized user.” You will be given points for this account’s age.

    Important: The Fair Isaac Corporation, which sets guidelines for the widely used FICO credit scores, is attempting to close this loophole. It might be a few years before this change takes effect, however, so you may still benefit from being an authorized user for a while. Spouses who are listed as authorized users on their partner’s credit cards should either switch their status from authorized user to joint account holder…or open their own accounts and start building their own credit histories to avoid credit problems when this change finally does occur.

What Makes Up Your Credit Score?

  • Payment history — 35%
  • Available credit used — 30%
  • Length of credit history — 15%
  • Types of credit used — 10%
  • New credit applications — 10%

Source: Fair Issac Corporation

*To obtain your credit scores, go to www.myfico.com.

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