by Amy Lillard
Credit and credit cards are an integral part of our economic system today. But there is a lot of misinformation and misunderstandings about credit. In this continuing series, we examine key concepts, tips and best practices when it comes to credit cards.
(10/15/2012) Credit scores are a convenient way for lenders and others to judge your credit. They distill down history, likelihood to pay on time, and diversity of debt into a simple number that lenders use to determine if you're a good candidate for loans or credit cards. It's also used by insurers to set premiums, by cell phone companies deciding to extend contracts, by utility companies determining whether to charge a deposit, and by landlords assessing if you're a good bet for a lease.
Since credit scores are so important, it's essential to understand them thoroughly, and to dispel some of the major myths and untruths that persist out in the world:
Lowering limits is a good idea. In fact, it's a better idea to have sizable credit limits. The bigger the gap between your available credit limits and the amount of credit you're using, the more attractive you are to lenders. Lowering your limits, perhaps to lower your temptation to spend or some other admirable reason, actually reduces that gap and could hurt your score.
High scores only come from paying down balances every month. It's always a great idea to pay down your balance as much as possible each month. This shows financial responsibility, and reduces interest payments. But you can carry a balance without hurting your credit score. Scores are compiled in part by looking at utilization — if you keep individual and overall balances below 25 percent, you can typically maintain a good score.
Keep every single account open to help your credit. As a general rule of thumb, closing an account after paying off the balance may not help your score. In fact, it may increase the utilization ratio, which can hurt your score. But there are reasons to shut down accounts. If you're paying a fee to keep an account open, and have other accounts open, it may be a good idea to close it. Timing is important however — if applying for a mortgage or new credit card, it's best to keep all accounts open for the time being.
There's only one credit score. In fact, there are hundreds of credit score formulas. They can come in slightly different iterations or major tweaks to suit specific lender's needs. Because of this wide variety, it's best to use the standard. When you seek out your credit score, ensure it's a Fair Isaac Corporation (FICO)-based score.
For Additional Reading:
11 Credit Report Myths: http://www.bankrate.com/finance/debt/11-credit-report-myths-1.aspx
7 Common Credit Myths Debunked:
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