Ways to Protect Credit and Your Score

As consumers, we know that having a good credit score is important. Whether you are applying for a loan or signing up for a credit card, learning ways to protect credit and your credit score should play a major role in how you use credit.

Presented by: Kris Maksimovich, AIF®, CRPC®, CPFA®, CRC®

Why is a credit score so important?

When you borrow money from a lender or sign a contract pledging to make payments, the other party needs to assess how likely it is that you will fulfill your obligations. Your credit score is a measure of risk that helps lenders quantify this likelihood in real time.

Credit scores also help to make the credit process more efficient. In order to make a decision about whether to lend money, a lender needs to gather a great deal of information. The credit score speeds up this process immensely by giving the lender a quantifiable measure without having to collect all the data. In addition, the efficiency of using credit scores does a lot to increase the amount of credit available, which in turn pushes down the cost of credit to consumers.   

Types of credit scores

The FICO^® Score, created by the Fair Isaac Corporation, is the most commonly used credit measure. Although in this article we focus on FICO, you should be aware that other scores—for example, VantageScore and PLUS Score—evaluate creditworthiness using their own methodologies.

A consumer’s base FICO Score ranges from 300 to 850—the higher the consumer’s score, the lower his or her risk to lenders. During the past 25 years, the base FICO Score has undergone many revisions, and the scoring methodology has evolved to account for new data points. Currently, the most widely used measure is the FICO 8 Score. (Fair Isaac has several other scores whose methodology is specific to the type of lending decision being evaluated. For instance, a bank may use a different FICO Score for mortgage lending than it does for making decisions about issuing credit cards.)

How a FICO Score is calculated

When a consumer obtains credit, the lender reports the information to the three major U.S. credit bureaus: Equifax, Experian, and TransUnion. The information then goes into the individual’s credit report, which provides the raw data used to calculate the credit score.

The credit report includes the consumer’s personal information (e.g., date of birth, social security number), all of his or her account information, information about credit inquiries, and negative information such as bankruptcies and late payments. For calculating an individual’s credit score, the FICO formula looks at five primary categories of information:

1. The consumer’s total amount of debt
2. The combination of different types of accounts
3. The consumer’s history of making payments on time
4. How old the consumer’s credit history is
5. The amount of new credit applied or shopped for

Although some categories like payment history and amount of debt are more heavily weighted in determining the FICO Score, the relative importance of a category can be affected by the aggregated information in the consumer’s credit report. 

5 Tips to protect credit and your credit score

Although judgments, liens, and bankruptcies can have a damaging effect on your score, it’s the little things that count. In fact, 65 percent of your FICO score is based on two key factors: your payment history and the amount of debt you carry versus the amount available to you (i.e., your credit card limits). Also important are your length of credit history, how much new credit you have applied for, and your mix among credit types.

Tip #1: Get your credit score. Although you can get a free credit report once every 12 months through www.annualcreditreport.com, the report does not include your score. You get a free score only if you have been denied credit or insurance. Many lenders will provide your score upon request after your application has been approved. If you want to know your score before applying, you can pay a small fee to one of the credit reporting agencies or go to www.myfico.com. Offers for free scores are usually tied to monthly credit monitoring services. It’s important to regularly review your credit and score.

Tip #2: Correct your information. It is a good idea to check your credit reports annually to ensure that they are accurate. Correct mistakes immediately with both the institution and the credit reporting agencies. These institutions have a responsibility to correct errors under the Fair Credit Reporting Act. Be sure to send copies of supporting documentation and keep a record of your request.

Tip #3: Understand your rating. FICO scores range from 300 to 850, with 850 being the best possible score. Generally, a FICO score above 700 is good; scores below 600 indicate a high credit risk.

Tip #4: Know how to improve your credit score. You can take the following actions to help improve your score:

• Pay bills on time. Create a system to ensure that you pay your bills in a timely fashion. Consistently paying bills on time will have a positive effect on your score.
• Pay down credit card balances. Reduce the credit card balances you carry to below 35 percent of your available credit limit; 10 percent is ideal. Do your best to keep balances on credit cards low compared with your total available credit line. High balances can hurt your credit score.
• Do not move debt around to avoid payments. Work on a system to pay down debt rather than move it.
• Use credit cards, but use them properly. Lenders want to see a track record that demonstrates your ability to manage debt responsibly.
• Cut up unnecessary cards but don’t close the accounts. Because your utilization rate counts as 30 percent of your FICO score, don’t reduce your available credit by closing old accounts. Instead, train yourself not to carry unnecessary cards or cut them up.
• If you are looking to obtain a loan, shop around within a short period of time. If you spread your search out over a long time frame, lenders may infer that you are shopping for many credit lines rather than for just one loan.
• Remember that the trend is your friend. As your credit “blips” recede into the past, your new habits have more weight. 

Tip #5: Avoid debt negotiation companies. Don’t be taken in by ads for companies that offer to get you out of debt by negotiating with creditors. You may get a reduction in your credit balance, but not without paying a high price. Moreover, if the company encourages you to walk away from your debt, you will also likely damage your credit score and wind up paying additional rates.

• If you are unable to make payments, contact the lenders to try to come up with a plan. You don’t need a third party to work out a modified repayment plan. Call the number on the back of your credit card, explain your situation, and ask to restructure your payments. You may be able to work with them in protecting your credit.

How can I make my credit card work for me?

To seek out new customers, credit card companies often send young adults and other prospects credit card applications in the mail. Typically, these mailings are unsolicited—you may have received a few yourself. But, before you sign on the dotted line and return that application, you should know a bit more about the dos and don’ts of credit cards to help you with protecting your credit score.

Credit Card Dos

• Shop around. The credit card industry is very competitive, so compare interest rates, credit limits, grace periods, annual fees, terms, and conditions.
• Read the fine print. The application is a contract, so read it thoroughly before you sign it. Watch for terms such as introductory rate, and be sure you know when that introductory interest rate expires.
• Pay your bill in full each month. Pay off your statement each month in full and on time; otherwise, you will begin paying interest charges and may be charged late fees. Paying off your bill each month can also help ensure that you stay out of debt.
• Track your spending. Look closely at your credit card statements each month to be sure that you actually approved the charges that appear. Mistakes can happen, and you don’t want to pay more than you agreed to.
• Pay attention to changes in your credit agreement. Occasionally, the credit card company will send you updates on the contract you have with it. If you don’t pay attention, you could miss something important. 

Credit Card Don’ts

• Don’t spend money you don’t have. Buying things without sufficient funds in your bank account can lead you down a dangerous path. Before you know it, you could be in a lot of debt with no way to pay it off.
• Don’t get too close to your maximum credit limit. Creditors want to see that you know how to use your card wisely. Keeping your balance low and making payments in full are good ways to do that. Just because the option to spend more is there doesn’t mean you should take advantage of it.
• Don’t sign up for store credit cards just to receive a discount. Opening a credit line at a store to obtain a discount on a purchase then and there may not be a good idea. Remember that credit cards affect your credit score and that opening too many can actually hurt it. Plus, store credit cards tend to have much higher interest rates than those offered by financial institutions.
• Don’t apply for additional credit cards if you have balances on others. Pay your balances on existing cards before opening new accounts. Getting into this habit will make you less likely to open too many accounts.
• Don’t give your credit card to someone else. Whether you authorize it or not, giving your credit card to someone else to use is against the law.

Although credit cards are important in helping establish a credit history and enabling you to achieve a good credit score, they are often misused. A credit card can be a powerful tool in the hands of a responsible individual, but it can be destructive if used by someone unaware of its pitfalls. Keep these tips in mind before obtaining and using credit.

Check out our carefully curated articles on credit and credit scores.

This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.

Kris Maksimovich is a financial advisor located at Global Wealth Advisors 4400 State Hwy 121, Ste. 200, Lewisville, TX 75056. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. Financial planning services offered through Global Wealth Advisors are separate and unrelated to Commonwealth. He can be reached at (972) 930-1238 or at info@gwadvisors.net.

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