How to Drive Yourself Crazy: Credit Scores
Posted by Justin McHenry in Credit
One of the more popular topics for finance writers to discuss is credit scores. Many appear obsessed with these numbers that FICO and others create based on an oh-so-secret formula and then sell to lenders to help them assess your credit risk. The higher your score, the better terms you can get on a loan.
Don't get me wrong, your credit score is important. Just because it's important doesn't mean you should spend a lot of time worrying about. Achieving a good credit score is easy to do if you follow these easy steps:
* Pay your bills on time (35% of your score)
* Don't carry massive amounts of debt in relation to your income (30% of your score)
Actually that's it. At least that's all that's worth worrying about and probably all that you can do much about. According to FICO, that's 65% of your score right there.
You can't do anything about the length of your credit history (15% of your score), getting new credit is only 10% of your score and the other 10% is lumped under "types of credit used" which is a nebulous standard not worth worrying about.
Here's why I'm on this subject today. Yesterday I read this article "Canceling a card does not help your credit score" by MarketWatch's Marshall Loeb. As the headline suggests, Loeb is telling you that canceling your credit cards to raise your credit scores won't work because FICO actually looks at the size of your debt in relation to the amount of credit you've been give—if you cancel a card you're actually increasing the ratio of debt-to-credit.
This is true, BUT…
Unless you are really on the fringe creditwise and need every single point you can get to help your credit score, you are better off canceling cards you don't need/want, taking the small, short-term credit score hit, and feeling happier and more in control of your credit situation. It's hard to reach financial Zen if you have this uneasy feeling that you have more credit cards open than you can even remember and you're not sure where those cards are, etc. What's worse, living with the stress or maintaining the almighty credit score?
Besides, if you continue paying bills and paying down the cards you have, your credit score will go right back up to where it was.
My advice: unless you have an impending loan such as a mortgage in your near future, don't give your credit score a second thought. Pay your bills, don't run up a huge debt, and live your life the way you want, without worrying that some faceless financial institution with only its own interests as heart may be frowning on your decisions.
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