No matter how much cash you’ve got, the worst thing you can do is neglect your credit cards. Young professionals in particular should use their credit cards to build and strengthen their credit scores, which can make the difference between being approved for or denied a loan.
Unless you understand how your credit score is determined—it’s about more than just making timely payments—you might be unwittingly sabotaging it. You should check your score annually—and under the Fair and Accurate Credit Transaction Act, everyone is entitled to 1 free credit report per year from 1 of the 3 major reporting agencies: Equifax, Experian, and TransUnion.
According to Jon C. Ylinen, a financial advisor with North Star Resource Group, it’s important for consumers to understand what criteria are used to determine
a credit score and how much weight each carries. Your credit score is calculated as follows:
35% is based on your payment history. Your score suffers if you pay a bill more than 30 days past due, although a few late payments won’t kill your score if your credit picture is good overall. Having a solid track record on most of your accounts will increase your score.
30% is based on your credit utilization. According to Ylinen, credit bureaus like to see you using 20% to 30% of total available debt. Consistently using more than that raises a red flag, showing that you are overextended.
15% is based on the length of your credit history. Longer histories increase your score, but also taken into account are the age of your oldest account, the age of your youngest account, and the average age of all your accounts. Having a lot of new accounts will lower your overall average even if you have had other credit lines open for years.
10% is based on the types of credit you have used. Credit bureaus are looking for a good mix of credit cards, mortgage loans, retail accounts, etc. If the bureaus see you are managing credit responsibly, that means you are less of a risk.
10% is based on new credit. This is composed of inquiries on your credit score (lenders requesting your report because you’re looking to open new lines of credit) and recently opened accounts, which lower your average account age.
Based on how your credit score is calculated, you should never cancel an old credit card
. Even if you’re no longer using it, if you’ve had a credit card for a long time you’ll be better off tossing it in a drawer than closing it. Canceling the card will most likely reduce your credit score by increasing your credit utilization ratio and lowering the average age of your accounts.
Have a question about how to handle your own financial challenges? Send it to us at email@example.com.