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STOP, BEFORE YOU DO THAT!

Here are some actions to avoid if your goal is to improve your credit.

1. Keeping a Running Balance

It’s a common misconception that carrying a balance on your revolving credit like credit cards will help your credit scores. (Tweet This) Many well meaning people tout that FICO likes to see a running balance on your credit card account and will “give” you more points toward your score if they see a balance at the time of score calculations. It’s a myth. Proponents of this thinking go like this: The purpose of credit cards is to buy things on credit (meaning borrowed money). It’s the convenience of buying something now, and paying later. Credit card issuers make their money on the interest they charge for you to use their money, so to speak, and they don’t start charging interests unless a balance is carried over from one reporting period to the next. Makes sense for the bank to hope you carry a balance. If a cardholder pays their balance off each month, the bank does not make any money. Likewise, say these myth propagators, FICO does too, and rewards you for carrying a balance. Read my lips: IT’S WRONG.

For scoring purposes, it’s different. FICO is not concerned if there is a balance, per se, but rather, they ARE concerned with your utilization ratio – how much you use compared with your credit limit. The less it shows you have used of your available credit when they take a snapshot of your credit activity, the less the ratio is and the better it looks to their score algorithm, thus, a higher score. Understanding revolving debt ratio is important to understand because it contributes to as much as 30% of your FICO score.

Tweet Tweet!   It’s Important to understand that as much as 30% of your FICO score comes from revolving debt ratio.

Running a balance in order to raise your score has the added risk that you will use more and more of your available credit, and coupled with interest charges, just puts you more in debt.

2. Buying Unnecessary, Often Large, Items on Installment

We all know that you have to have credit to get credit, and, therefore, must use credit, but one of the biggest mistakes we make when using credit and especially for the purpose of building good credit is to succumb to the “buy now, pay later” temptation and buy things we don’t really need now, on a type of credit called installment loans. Installment loans as a loan type are the least important type of credit for building your credit score. It only contributes toward 10% of your score, and even then, not directly but only as a part of what FICO calls one’s mix of credit. Additionally, it increases your indebtedness for the entire length of the loan term. Don’t go out and buy that large screen T.V., or car, or new living room furniture on installment if you can wait, and especially if you are in a credit building phase.

3. Closing Old Accounts

There are finance “gurus” preaching that the best thing to do is just pay cash for everything and forget about credit saying, “if you can’t afford to pay cash you don’t need it”, and then commence to advise their listeners to cut up their credit cards. This advise sounds good on the surface and in theory would be nice, but it is short-sighted, and forgets that even if the only thing you ever do on credit is get a mortgage to buy a home, you have to have credit to get credit – not to mention mortgage lenders like to see 2-5 open trade lines for mortgage approval. Since FICO considers the length of credit history as one of the determining factors in calculating your score, don’t indiscriminately go on a card-closing-frenzy.

Tweet Tweet!   FICO considers the length of credit history when calculating your score. Don’t go on a credit-card-cutting frenzy.