Barry is the sort of credit risk most lenders dream of, and a recent report suggests he's not alone in the habits that got him there.
A 57-year-old consultant from the Boston area, Barry (his last name is excluded to protect his privacy) has a sterling credit score of 805. He's militant about paying his bills on time. He has several credit cards, but doesn't touch them except for one that occasionally offers interest-free loans.
"I have done that at times, occasionally during a slowdown in my business, but have been very careful to pay the full amount off before the zero interest period expires," he said.
Stellar credit is no accident, according to CompareCards.com, which says consumers who consistently maintain high credit scores share certain habits and traits.
But critics of the credit scoring system say there are other people like Barry who are a low credit risk but lack the high credit score to prove it. Given the current credit rating system that encourages borrowing and doesn't consider a borrower's personal savings or other resources, laudable financial habits only push them down the credit score ladder.
Six habits for solid credit
Consumer credit scores are calculated using what’s known as the FICO system, named after the California software company that developed the methodology. The system, using “predictive analytics,” takes five factors into account — payment history, debt burden, credit history length, credit mix and recent credit searches — to predict a consumer’s future credit use.
The resulting credit score ranges from a low of 300 to a high of 850.
CompareCards.com's blog said one of the most critical solid credit habits is never, ever missing a payment.
“Once you start missing payments, you can be seen as less reliable or more forgetful,” said site content coordinator Kari Luckett. “And once you start getting penalties and fees, it can quickly steamroll into a larger problem.”
Another important factor is credit utilization — using only a modest amount of the credit available to you. As a general rule of thumb, the report said, high credit score holders never access more than 30 percent of the credit they can actually use.
Other high credit attributes identified by the report included never maxing out on a credit card’s limits, managing several types of credit lines (such as a mortgage, car payments and credit cards) and keeping a watchful eye on your credit score.
“It’s always a good idea to stick with the same credit cards for a long time,” said Gerri Detweiler, director of consumer education for Credit.com. “And maxing out on a credit card will always hurt your credit score. But if you know your limits and are careful how you use the card, you should be able to stay well below the maximum limit.”
Other healthy habits
A credit score element bypassed by the CompareCards.com report is credit searches. Although a relatively modest factor — accounting for just 10 percent of the overall tally — credit searches can negatively impact a score if a consumer shops around too often for new or different lines of credit. So the reasoning goes, too many inquiries can suggest a credit holder who’s having a hard time managing what credit he or she already has.
Detweiler acknowledged the growth of resources such as the Internet can tempt card holders to go overboard in constantly looking for new or more attractive forms of credit. The key is knowing when to put on the brakes on applying for a card that may have a slightly lower interest rate or a better rewards program. If you do pursue new credit, make sure the terms are sufficiently attractive, such as two to three points lower in interest than what you’re carrying now.
“It’s not that you can’t shop around,” she said, “you just need to shop very carefully.”
Detweiler disagreed with one credit habit identified in the CompareCards.com report — never paying an annual fee to use a card.
The report cautioned:
“Paying an annual fee to carry a credit card isn’t just annoying, it’s throwing money away. If at all possible, find the credit cards that do not have annual fees and still come with rewards.”
Not necessarily, said Detweiler. Cards with annual fees but that also have low interest rates, generous benefits and other valuable features that more than offset the yearly expense can be solid choices.
In fact, the CompareCards.com report does seem to walk back on its caveat: “Some of the best cards with the most benefits and features do come with an annual fee, so if your card is packed with benefits such as premium concierge service, then carrying that card makes perfect sense.”
The 'invisible' good credit risk
One of the report’s solid credit habits — checking in on the status of your credit score on a regular basis — recently received a shot in the arm. Earlier this year, several banks announced they would start providing credit scores to their credit card holders in 2015 — information that had long been kept out of consumers’ sights.
However positive, that news will likely be met with a noncommittal shrug from many who contend that the credit scoring system is inherently flawed. For one thing, they argue, the essential focus of the credit scoring methodology is misdirected.
“The only thing the scoring model is designed to do is to predict how likely someone will be 90 days late with a payment over the next two years,” said New York attorney Jason M. Kaplan, president of thecreditpros.com and board member of the National Association of Credit Service Organizations. “Pull a million people’s credit reports, then pull another two years later and find common characteristics for being late. That’s a lot of stuff that’s left off the table. You don’t get the real story.”
What’s missing, Kaplan added, are factors such as savings, income and other financial resources — the means to meet financial obligations such as credit that the credit scoring system completely bypasses.
Moreover, one of the credit system’s salient measuring points — credit history — effectively discriminates against ideal consumers: well-disciplined spenders who pay for what they can afford with little need of widespread credit.
Detweiler acknowledged that the credit system can work against so-called “credit invisibles” — people with ample financial means but little in the way of credit history. But, she added, even consumers who are gun-shy about accessing credit for the sole purpose of establishing a reliable history don’t have to sign up for every credit card within reach.
A single credit card and some other form of credit such as a mortgage or car loan are usually sufficient.
“Even limited credit use can help you establish a solid credit history,” she said. “You don’t have to go overboard to build great credit.”