Truths and Myths of Credit Cards and FICO Scores

Credit and credit cards have taken on new meaning and attention since the credit crisis. In recent months, credit has been much harder to come by as the economy has continued to contract. Knowing how to maintain and/or improve your credit score in order to hang on to your available credit has never been more important, and understanding credit scoring and credit in general can save you from sabotaging yourself. Take the short true of false quiz below and see how much you know about the industry. The answers, along with valuable information regarding the fact or myth, appear below the test.

True or False?
True or False? Answer the questions below without looking at the answers in the answers section. Once you’ve answered them to the best of your ability, scroll down to find out if you’re correct, and learn important information about credit cards and FICO scores.

1. Your FICO score is a predictor of your future lending risk.

2. Canceling a credit card is a positive step in boosting your FICO score.

3. Having too much credit available can negatively affect your FICO score.

4. Unpaid library fees and parking tickets don’t hurt credit scores.

5. Credit card companies can close unused accounts.

6. Even if you make your credit card payment on time, a credit card company can raise your interest rate if you are late on payments elsewhere.

True or False Answers
1. True. The FICO score, developed by Fair Isaac & Company Credit Organization, determines the likelihood of borrowers paying their bills. Lenders use this score to decide whether or not you are a good lending risk. Among other things, the FICO score takes into account:

• late payments
• the amount of time the line of credit has been established
• the amount of credit used versus the amount available

2. False. 30% of your credit score is determined by the amount of debt owed versus the amount of credit available. If you close a credit card account, especially without changing the amount of debt owed, you reduce your available credit, thus throwing off the debt owed vs. available credit ratio. If you close an account you’ve held for a long time, your credit score is further negatively impacted, as length of credit history significantly adds to your rating.

3.Trick question. True and False. A lot of available credit isn’t generally a problem. Let’s reword that. A lot of available credit isn’t a problem as long as you keep the amount of debt owed at less than 30% of the credit you have available. In some cases, depending on your income and your ability to pay debt at a given time, you may want to keep it much less than that.

One exception: If you’re planning on taking out a new home loan, or other significant loan requiring you to borrow large sums of money, having large amounts of available credit could hurt you. To lenders of this degree, the amount of available credit you have is deducted from what they can lend you. If you have it, you can spend it, and they’re not willing to take this risk. Several months before you plan to take out a large loan, close some accounts, but not accounts with long history or good debt to available credit ratio.

4. False. Government and private organizations have taken to reporting unpaid fines to credit agencies as a way to try to collect what they are owed.

5. True. Recently, lenders have become nervous about people having large sums of credit at their disposal but not using it. You don’t have to charge thousands of dollars each month in order to keep your account open, but do charge a couple bucks here and there just to ensure your account isn’t shut down. Remember: If a credit card company does close your account, your amount of available credit is reduced, thus negatively impacting your credit score. If the company doesn’t close your account, they may stop reporting it to credit bureaus, which also reduces your amount of available credit.

6. True. And they can raise your rates immediately and automatically.

Further Reading

“Secret History of the Credit Card”
via PBS

“Can Canceling a Credit Card Really Hurt My Score…”
via The Consumerist

“Trash Your Credit Score”
via The Dollar Stretcher

“5 Credit Card Company Tricks and How to Thwart Them”
via Get Rich Slowly

“Eight Things Every Credit Card User Should Know”
via Get Rich Slowly