We've known the basics of how credit scoring works for nearly a decade now. Yet I still hear from readers who think they can improve their credit, or their finances, by closing accounts or having their credit limits lowered.
This behavior stems, I believe, from the still-widespread myth that you can have too much credit.
Here's the reality: There's no such thing as too much credit, unless you're a debt addict. If that's the case -- if you've never seen a credit card you couldn't max out -- then this column is not for you. You should cut up your cards, seek counseling and pay off your debt.
Most people, by contrast, handle credit more or less responsibly. Forty percent of cardholders regularly pay their balances in full, according to Federal Reserve statistics, and half of those who do carry debt owe $3,000 or less.
It's those folks I'm talking to. And I'll say it again: There's no such thing as too much credit, particularly these days.
Here's why:
- Having "too much credit" isn't a negative for FICO scores. You might get dinged for opening the accounts, but the FICO scoring formula (the one used by most lenders) doesn't penalize you for having too many once they're opened. If you get a score and are told the reason it isn't higher is because you have "too much available credit," you probably didn't get a FICO score but one of its competitors. "We just went through the full list of reason codes for FICO scoring, and it contains nothing remotely like 'too much available credit,'" said Craig Watts, a FICO spokesman.
- Lots of available credit typically helps your credit scores. Once they're established, credit accounts typically improve your scores as long as you don't pay late or max them out. The FICO credit-scoring system is very sensitive to the gap between the credit you use and your available limits. The bigger the gap -- on each account and overall -- the better for your scores. Closing accounts or asking for lower limits shrinks that gap and can hurt your scores.
- Your income isn't a factor. I've read a lot of well-meaning but completely inaccurate advice about how you should limit your available credit to a certain percentage of your income (with the percentage varying by how much credit the particular writer has). This is nonsense. Credit-scoring formulas don't even take income into account.
- Lenders may care, but they probably won't. Before the advent of FICO scores, many lenders were suspicious of those with "too much credit," worried these borrowers would suddenly rush out, max out their cards and then default. FICO's research indicates this fear was overblown -- if you've handled credit responsibly in the past, you're likely to continue to do so -- but some lenders are still wary. If you run into one of those, you can placate them by closing accounts, but you risk damage to your credit scores.
- Credit card issuers have gone a little nuts. In their efforts to reduce their risk, many credit card companies have been slashing limits, raising rates and closing accounts. Now they're threatening to add new fees. (Read "Banks have declared war -- on you.") Some have taken more-drastic steps by targeting not just risky borrowers but good customers who have always paid on time. The people who are in the best position to fight back are those who can simply take their business elsewhere. If you have plenty of other established accounts, you can start using them instead and transfer any balances. Also, a lower limit on one card isn't a credit-scoring crisis if you have lots of other cards.
- You don't need to worry that much about fraud. Yes, identity theft is a real problem, but if one of your existing accounts is hijacked, you're not responsible for the bogus charges if you report them within 60 days. If you have so many accounts you can't keep track of them, you may want to winnow the herd, but most people can remind themselves to log in to their accounts every month or so to check their charges.
I'm often asked how many credit cards are optimal. Alas, FICO is mum about that. But FICO does say the typical U.S. adult has four to five credit cards. And some of us have a lot more.
I hesitate to use myself as an example because individual experiences can vary so much with credit scoring, but at last count I had between seven and 17 open, revolving accounts showing on my credit reports at the three major bureaus. (The bureaus are private businesses in competition with each other, and the information they report is often different.) My FICO scores typically range from the high 700s to the low 800s (the top score is 850; anything over 760 or so typically wins the best rates and terms). Clearly, my scads of available credit aren't hurting my scores.
What does ding your scores, as I've said, is opening and closing accounts and maxing out your cards. So use the following guidelines:
- Apply for credit sparingly. Applications are counted as "hard" inquiries and typically lower your scores. Although the damage of one inquiry is usually slight -- 5 points or less -- applying for a bunch of accounts in a short period could tag you as high-risk, because you'll seem suddenly desperate for credit.
- Close accounts sparingly. If you decide you must close accounts, shut down retail accounts first (those department store cards you got because of discounts), and try to keep open your major credit card accounts, particularly those with the highest limits.
- Use only a small portion of your available credit. Whether or not you pay your balances in full each month -- and you should -- you still want to use only a fraction of your available credit: 30% or less is good, 10% or less even better. The balance that's reported to credit bureaus and used in your scores is typically the balance from your last statement. If you used 50% or more of your limit, even if you paid it off in full, you could be hurting your scores.
- Push back against credit limit cuts. If you're a good customer with high credit scores, point that out to the offending issuer. If it doesn't reverse its decision, take your business elsewhere.