Ask Liz Weston

Dear Liz: You’ve written that it’s generally better to have small balances on several credit cards than a big balance on one card. Would you please elaborate on this?

When it comes to revolving credit, it was my understanding that the credit score is looking at the total utilization for all revolving debt. For example, I have the following: a Visa card with a limit of $10,000 and a balance of $5,000, another Visa card with no balance and a $20,000 limit, and a furniture store card with a $2,000 balance and a $5,000 limit.

My total revolving credit available is $35,000 and my utilization is $7,000 or 20%. Before reading your article, I was considering transferring both balances to the high-limit card. My utilization would still be 20%, so why would it be better to leave the balances on the other cards?

Answer: The leading FICO credit scoring formula looks at both your overall credit utilization and the credit utilization on each card. That’s why the company that created the score, also known as FICO, advises that in general it’s better to have small balances spread across several cards than a big balance on one card.

In your case, however, shifting balances would probably leave you better off. Instead of credit utilizations of 50%, 0% and 40%, you’d have utilizations of 0%, 35%, and 0%.

There’s no hard and fast rule about how much of your available credit you should use on each account. The less you use, the better.

Dear Liz: As a result of the implementation of the new credit card legislation, my card issuer for the first time is going to charge me an annual fee of $60, effective April 1. I am strongly considering canceling my credit card because I rarely use it. I have two other cards that I use on a regular basis. But I heard that canceling a credit card can hurt your credit score. Is this true? If so, how many points could I lose?

Answer: Yes, closing cards can hurt your credit score, but it’s impossible to predict in advance how much. Typically, the lower your scores and the fewer open card accounts you have, the more you should avoid closing accounts. You also don’t want to close accounts if you’re about to apply for a major loan, such as a mortgage or car loan.

Because you have high scores and two other open accounts, though, you may be able to close this card without a huge effect on your scores, particularly if it’s not your highest-limit card. (Credit scoring formulas are sensitive to the amount of your available credit you’re using; most of the negative impact of closing a card comes from the reduction of available credit.) If you’re not in the market for a major loan and the issuer won’t rescind the fee, it’s certainly an option worth considering.

Dear Liz: I got my credit reports and scores from a website that said my credit score for one bureau was 699. Then I went to MyFico.com, which said my score for that bureau was 601. Which is right?

Answer: The MyFico score is likely to be closer to the score an actual lender would use.

Many sites promise to give or sell you credit scores, but these scores typically don’t use the FICO scoring formula that most lenders use. The scores you get from other sites can give you a general idea of how lenders may view your creditworthiness but often vary substantially from your actual FICO scores.

Dear Liz: What is the best source for a free credit report with no strings attached (that is, you’re not required to sign up for credit monitoring or other offers)?

Answer: The one and only site to get your free, federally mandated look at your credit reports is AnnualCreditReport.com. There are plenty of look-alike sites that try to fool you, so make sure you get to the right one.

Also, be aware that you’re entitled only to free credit reports, not free credit scores. If you want to see the FICO scores that lenders use, you will have to buy those at the MyFICO site. If you want to see free credit scores that aren’t FICOs but that give you some idea of where you stand with lenders, visit the Credit Karma site.

Dear Liz: Lots of “credit card remedies” are being marketed now. Is debt settlement a reasonable way to reduce debt? I have a good track record of payments and good credit scores (my median FICO score is 745). I’m concerned I’ll damage my creditworthiness for years to come.

Answer: Debt settlement means you’re paying less than you owe — and creditors really don’t like that. Debt settlement can trash your credit, which is why it isn’t a good option if you can find other ways of dealing with your debt.

If your interest rates are relatively low and you can easily make your minimum payments, your best bet is to simply pay off the debt on your own, throwing as much money as possible at your highest-rate card while paying the minimums on your other debt. Once your highest-rate debt has been retired, you can apply that payment to your next highest-rate debt, and so on until you’re debt free.

Or you can transfer your debts to a fixed-rate personal loan and pay that off over time. Many credit unions offer three-year personal loans at rates of 10% to 15% to people with good credit.

If you’re struggling to make your minimum payments, you should arrange two appointments: one with a legitimate credit counselor (you can get referrals from the National Foundation for Credit Counseling at www.nfcc.org) and another with a bankruptcy attorney.

The credit counselor may be able to put you on a debt management program to pay off your debt at lower interest rates. Credit counseling is a neutral factor in credit scoring formulas — neither helping nor hurting — but your creditors may report you as late, which could hurt your scores.

Bankruptcy would really trash your scores, driving them down into the 500s. But it could wipe out your debt and give you a fresh start if you aren’t able to pay your bills.

What you want to avoid, if possible, is raiding retirement funds or home equity to pay credit card debt, particularly if bankruptcy may be an option. Retirement funds are protected in Bankruptcy Court and so, in many cases, is home equity.

Credit card rates are going back to the future.

Instead of a wide range of rates based on the borrower’s risk profile, credit card companies will move to toward a single-rate system for all their customers, Discover CEO David Nelms told the Salt Lake City Tribune recently.

The Credit Card Accountability, Responsibility and Disclosure Act will benefit some people and hurt others, said Nelms, who was in Utah visiting the company’s largest call center operation Tuesday, in West Valley. For those with good credit, “the ultra-low rates of the past 10 years aren’t going to be available anymore.”

That’s how credit card rates used to work, back in the days before credit scoring. One rate, usually around 18%, for all customers–and folks with bad credit need not apply at all.

In February 2008, I warned that “The credit card party is officially over” as rising defaults and the credit crunch led issuers to start raising rates and lowering credit limits. That trend only accelerated after credit card reform passed. Balance transfer offers have gotten much less generous and rewards programs are about to suffer, as well. (I’ll be writing about that next week for MSN Money.)

All told, it’s a good time to get that credit card debt paid off. If you still have a low rate after Feb. 22, when the last of the CARD Act reforms kick in, you should be able to keep it unless you’re late paying by 60 days. Otherwise, you might want to consider locking in a lower rate with a personal loan from a credit union. With good credit, you could get a three-year loan with a fixed rate around 10%.

Dear Liz: We are fortunate to be debt free with a nice cash reserve. We typically pay our bills in cash, by check or by a credit card that’s connected to our brokerage account. Imagine our surprise when we applied for credit at two retail stores to get a discount on items we wanted and were turned down on the spot at both places. We have asked for, and received, the government-required reports from the three major credit bureaus, and the information provided seems correct, to the best of our interpretation. Short of a significant effort to get more credit, which we can survive without, what do you recommend we do?

Answer: Under the Equal Credit Opportunity Act, you have a right to know why you were turned down for credit. Simply referring you to the credit bureaus isn’t sufficient — the retailers should have given you the reasons your applications were refused. If you haven’t received letters by now explaining their rationale, write each retailer’s credit-granting department and point out that they’re required by law to give you an explanation.

It could be that your scores weren’t high enough. Even though your finances are in good shape, the fact that you have only one active credit account might be damping your scores. If that’s the case, simply adding another credit card could boost your scores and make you eligible for instant credit offers.

Or it could be your scores are fine and the problem is your income, or what the retailers think your income might be. Credit card lenders are under regulatory pressure to consider borrowers’ incomes, and some are using various services that purport to estimate incomes based on other information in your credit reports, such as the size of your mortgage or your credit limits. If you have no mortgage and only one card with a low limit or no limit reported, that estimate could be way off.

But you don’t have to guess. The retailers should tell you. If they don’t, you can report them to the Federal Trade Commission.

Dear Liz: I am trying to rebuild my credit and am following many of the tips I’ve read in your articles. I recently obtained a secured credit card and an auto loan just to help with rebuilding my credit. Can I increase my credit score even if I pay off the entire credit card balance due each month before any finance and interest charges are incurred? And can I increase my credit scores over time even though I currently have a tax lien and judgment on my credit report?

Answer: Let’s tackle your last question first. You can mitigate the effect of serious negative marks such as tax liens, judgments, bankruptcies, foreclosures or repossessions by being responsible with your other credit accounts, but these missteps will still drag down your score as long as they’re on your credit reports. Most negative marks will drop off after seven years, although bankruptcies can be reported for up to 10 years and there’s no limit to how long unpaid tax liens can remain on your report — which should be a good incentive to pay those off.

Being responsible with your credit accounts means paying them on time and using only a fraction of your available credit card limit. (Using less than 30% is good, and using less than 10% is even better.) It does not mean you have to carry a balance. Credit reports and credit scores typically don’t distinguish between balances that are carried month to month and those that are paid off, so you might as well save the finance charges and pay your bill in full each month.

Dear Liz: I applied for a 10-month, interest-free loan at an appliance store to purchase a washing machine and was refused. We own our house, have no outstanding debt and pay our credit cards in full each month. I’m worried that if something happens to my husband and I want to buy a car or whatever I need, I won’t be able to get credit.

Answer: If you were turned down for credit, you should have been given free access to the credit report the lender used to make its decision. In any case, everyone in the United States can get a free look at their credit reports from the three bureaus once a year at www.annualcreditreport.com. You should peruse the reports to see whether there are any obvious errors, such as accounts that aren’t yours or late payments when you paid on time.

The problem could be that all the credit you have is in your husband’s name. If that’s the case, you should begin building your own credit. If you’re already an authorized user on his cards, see if the credit card issuers will report the accounts to your credit reports as well as his. Opening a credit card account in both your names, as joint account holders, also can help build your history.

Dear Liz: I am a divorced 49-year-old man who has a lot of debt. I recently (and shamefully) turned in the keys on my ridiculously upside-down home in Arizona. My credit scores have plummeted and all my credit cards have raised their rates to 28% and above.

I am remarried to a wonderful woman who is more fiscally responsible and wants to buy a home. I’d like a quick fix, but that seems unlikely. I’ve avoided commingling our assets and credit so far, but recently I asked my wife to cosign a personal loan to consolidate my debt. I’ve also requested to be an authorized user on some of her high-limit, low-balance credit cards.

I fear this may be a break point for our relationship. She has worked hard to be responsible and I — well, I have not. My strategy seems sound. What do you think?

Answer: Your plan could dramatically lower your interest costs, allowing you to repay your debt more quickly. It also could help rehabilitate your battered credit scores.

But the cosigned loan would put your new wife’s credit in your hands. If you missed a single payment, her hard-won credit scores could plunge overnight. If you failed to pay the debt, she would be responsible for it.

That’s a huge risk for her to take, so you shouldn’t hold it against her if she declines. Adding you as an authorized user of her cards involves much less risk, since she wouldn’t have to actually give you access to those cards, but she’s under no obligation to do that either.

If she turns you down, you might want to consider a visit with a legitimate credit counselor (one affiliated with the National Foundation for Credit Counseling) as well as a session with a bankruptcy attorney so you can be apprised of all your options regarding your debt.