Credit score Q&A: What you need to know

Herb Weisbaum • Profile • E-mail

Last week’s column on credit scores generated a lot of comments and questions. Olga, who says she has excellent credit, sent me an e-mail that sums up the frustration of so many. “I feel that no matter what a consumer does, no matter how careful you are with your credit, whatever you do, they tell you it could lower your credit score. A consumer cannot win!”

I understand the frustration. Your credit score now controls so many aspects of your life: whether you can rent an apartment or get a car loan, credit card or mortgage. I think everyone knows late payments will hurt their score. But other than that, most don’t have a clue as to how credit scores are computed.

Here are the answers to some of your questions.

Q: A department store chain is going out of business and I have one of their store-branded Visa cards. The bank that issued the card says once the store closes its doors for good they will close my account. Would it be better for my credit score if I close the card myself before the bank does?

A: It doesn’t matter who closes the account. That isn’t one of the factors considered when computing your credit score. But closing an account – whether it’s done by you or the lender – can have a short-term negative impact on your credit score. This is due to what’s called debt utilization – the ratio of your total debt to total credit limit – and it counts for about a third of your credit score.

“Closing a credit card reduces your available credit, but doesn’t reduce the amount you owe, making it look as if you’re using more of your available credit,” explains Greg McBride, senior financial analyst with bankrate.com.

Here’s how that works. Let’s say you have four credit cards and each has a $5,000 limit, making your available credit $20,000. You have no balance on one card and a combined balance of $6,000 on the other three. Your utilization rate is about 30 percent. That’s not bad. Credit experts say you should try to use 30 percent or less of your available credit.

What happens if you decide to close the card with the zero balance because you don’t use it anymore? Your available credit drops by $5,000 but your total debt doesn’t change. So your utilization rate jumps to 40 percent ($6,000 debt on $15,000 of available credit) and your credit score will drop.

Craig Watts, public relations manager at Fair Isaac, the company that created the FICO score, says if you close a card and you have virtually no balance on your other cards “the impact on your score will be negligible.”  Watts says it won’t hurt you if you go from a 2 percent to a 10 percent utilization rate. But jump from 10 percent to 50 percent and “you’ll get clobbered.” So you need to do the math before you close an account.

If you have a good reason to close a card, such as a big annual fee on a card you don’t use, then consider closing it. Just don’t close a bunch of cards at once. And don’t close credit accounts if you plan to apply for a car loan or mortgage in the next six to twelve months.

Q: Why do we have to pay a fee in order to see our credit scores? Annual credit reports are available at no charge. These scores are so important, why aren't they free as well?

A: Congress never included credit scores when it required the big three credit bureaus to give you one free credit report each year. Many consumer groups believe this should be changed. But the industry makes a lot of money selling these scores.

Want to know your score? You'd be smart to get it from FICO because it’s the most widely used score. If you’re applying for a mortgage, you'll also want to get a score from Experian. They no longer make their FICO score available to the public.

Bankrate.com has a FICO Score Estimator, a free calculator that will give you an estimated range for your FICO score based on 10 questions. It's a simple way to figure out where you stand when you have no plans to apply for credit.

ConsumerMan warning: Don’t respond to an e-mail or Internet ad from some unfamiliar company. Chances are your lender will never use this score.

MORE FROM CONSUMERMAN

ConsumerMan Section Front

ConsumerMan: Fed overdraft rule not enough Chinese drywall a big threat FTC nabs Moneygram Death in the digital age Free samples? Just say no ConsumerMan mailbag: Car rip-offs and more ConsumerMan Section Front   Add ConsumerMan headlines to your news reader: