Letting your credit cards work for you
Using your plastic IS great way to build solid credit, experts say
Do you put credit card offers directly in the recycling bin? You may be throwing away one of the easiest ways to improve your credit score. Managing credit cards wisely can drive up your credit score and save you a lot of money on loans and lines of credit. "Put credit to work for you," said Maxine Sweet, the vice president of public education for Experian, a credit reporting company. "Credit is not bad, it's bad if you use it badly. I encourage people to look at it as a tool that they manage. You can get good rates, rewards, frequent flier miles. You use it, don't let it use you."
Credit Cards Show Good Management
Anyone who hopes to qualify for a loan has to have a credit history, and that includes any money you've ever borrowed. From car loans to student loans and store credit, all borrowed money ends up in your Fair Isaac and Co. -- or FICO -- score. The score is the way banks determine your credit-worthiness. Sweet said that unlike a car note, in which the borrower always knows exactly what amount is owed each month, a credit card balance can change from month to month. Showing creditors that you're a good steward of revolving credit strengthens your FICO score. "The most important thing to improve your score is to have a credit card. An installment loan is a fixed payment and you don't have to manage surprises," Sweet said. "A credit card is self managed and you decide how much you charge each month, how close you get to your limit, whether you let it grow each month or pay it off."
FICO is the scoring system used by the big three credit reporting bureaus. There are other formulas that some creditors employ, but FICO is the most widely used. The first step to managing your credit score is knowing what's in your credit report. At AnnualCreditReport.com, you can request a free credit report once every 12 months from each of the nationwide consumer credit reporting companies: Equifax, Experian and TransUnion. Your FICO score can range from 300 points to 850 points. Aim to be at or above 700, according to Jeff Krejci, the president of First State Bank in Lincoln, Neb., and the chairman of the Nebraska Bankers Association. Krejci said a score below 600 wouldn't allow him to make a home loan. "At 600 to 620, it would mean a higher fee. Up to around 700 and above that -- no additional fee," Krejci said. So managing your credit score wisely means saving money when it's time to borrow money. Thirty-five percent of your FICO score is based on your payment history -- are you current with the payments you owe or have you missed some? Fifteen percent of the score looks at how long your credit history reaches back and 10 percent figures in how many inquiries you've had on your credit history. Lenders look at the inquiries to determine whether you're suddenly asking for a lot of credit, and since the credit reporting bureaus lag about six months behind, brand new credit wouldn't show up in your history. A full 30 percent of the FICO score is based on how much debt you have available to you versus how much debt you hold. That ratio is easily managed with credit cards.
Get Your Ratio Right
"Consumers charged to the max are high risk," Sweet said. "A $20,000 limit (over several cards) with just $4,000 charged is better than one card with a $5,000 limit with the same $4,000 charged. You want to show you're not charging up to the max." Call current creditors to see if they'll raise your maximum. That's a quick way to lower your debt ratio. Getting the ratio right means can also mean taking the long view. If you want to take out more credit cards to raise your score, do it over time. Remember that 10 percent of your FICO score considers how many credit inquiries you've had. If you apply for 10 new credit cards in three weeks, you could damage your FICO score in your scramble to raise it. "Many inquiries in a short period of time might suggest you are trying to take on large amounts of debt. Both issues are signs of risk," Sweet said. If you're worried you have too many credit cards, don't break out the scissors. In an online Q&A on Bankrate.com Leslie McFadden wrote: "As long as it's on the credit report -- whether it's open or closed, low balance or no balance, or old or new -- if it's on the report, the score is going to count it when counting that mix or when looking at the ideal number of cards … Closing it is never going to help your score."
Open Accounts With Discretion
Krejci said store credit cards are a good way to build a credit history, but don't go overboard. Store cards often offer 10 to 20 percent off on the items bought the day you apply, but many carry the highest interest rates going. Some people are tempted to spend more money in a store where they hold a card, and that can put your credit score in jeopardy. "So many people are using credit to live beyond their means," Sweet said. "In an ideal world, everybody would pay in full and you'd use your credit card for convenience. There are times when it is neat to be able to use credit where you can spend more than you pay in one month, or at holidays, or for emergency, but you've got to stop and create a plan to get it paid back. It keeps your revolving balance low." "Manage your debt so that 28 percent of gross monthly income is your housing payment -- 38 percent for all payments to creditors," Krejci said.