Ask Liz Weston

Dear Liz: I have no idea what my credit score is, because as my father said, “You never get rich paying someone else interest.” The only reason to borrow money is for a house or a car or for a home improvement for which a home-equity loan would be best. Credit cards, consumer loans and home-equity loans for non-house expenses are folly.

However, you and many other financial columnists are always advising people on how to keep their credit scores high. The implication is that your readers should be borrowing money when they should not. I use credit cards (for most of my purchases, in fact), but I always pay off my balance, so my credit scores are of no interest to me and I don’t know them.

Answer: You’re laboring under two common misconceptions: that credit scores aren’t important and that you have to have debt to have good scores.

It’s precisely because you don’t get rich by paying others unnecessary interest that you should care about your scores. The reality is that good scores have become critically important if you want the best rates and terms on mortgages, auto loans and other lending.

Credit scores are also used by landlords to evaluate applicants and by insurance companies to determine premiums.

But you don’t need to carry credit card balances to have great scores. In fact, the only smart way to use credit cards is to pay your balances in full each month. You also need to pay attention to your credit limits, since maxing out cards, even if you pay in full, can hurt your scores.

Dear Liz: I began paying down my debt six months ago and have paid off $10,000 so far. I subscribed to a credit score tracking system through a free offer and was told my credit score was in the 670 range most of the time. When I applied for a mortgage loan recently, however, the bank told me my middle score was only 612. One credit bureau said my score was just 590! How is this possible?

Answer: There are many different credit scoring formulas available today, but the one used by most mortgage lenders is the FICO. You have FICO scores from each of the three bureaus, and mortgage lenders typically use the middle of those three scores to determine your rates and terms.

Unfortunately, many of the companies hawking “alternative” scores don’t make it clear to their customers that they’re not seeing a FICO score. The confusion is compounded by the fact that your credit scores, including your FICOs, change all the time, and lenders also use somewhat different versions of the FICO scoring formula, which can produce somewhat different results.

Still, for a score that’s closest to what your lender will see and use, you want FICOs. You can buy your FICO scores for two of the three bureaus at MyFico.com. Unfortunately, Experian no longer sells FICO scores to consumers, although it continues to sell them to lenders. That means you can no longer know in advance what rate you qualify for, since you can’t know what your middle score is until your lender gets all three.

Dear Liz: My fiance and I are trying to secure financing for our first home, but his credit scores are just below the mark. I was thinking of adding his name to my credit card account so that my available credit line shows up on his report. Would this boost his scores at all? Is there any danger of it lowering his scores?

Answer: If you have a good history with this account — you always pay on time and you’re not carrying a large balance — adding him as an authorized user may help his scores.

The key is whether the credit card issuer will “export” this data from your credit file to his. Some issuers automatically do this export for any authorized user; others do so only for spouses. The only way to know for sure is to ask your credit card company.

If the data is exported to his file, it will be used to calculate his FICO scores, which are the scores most lenders use. The company that creates the FICO briefly toyed with the idea of excluding authorized user data in its latest formula, FICO 08, but ultimately decided to continue using it.

If you add him as an authorized user, you don’t need to give him a card or access to your account. What you should do, however, is take some time to go over his credit reports and discuss what steps he’s taking on his own to clean up his financial act.

A temporary boost in his scores might land you a mortgage, but you could wind up much worse off financially if he continues to mishandle his credit.

Despite concerns that credit card limit cuts would devastate consumers’ credit, scores nationwide seem to be holding steady, according to Credit Karma, a score-tracking site.

Credit Karma’s latest survey found 34% of consumers saw their credit score stay the same in June compared to 32% in May. Nationally, 28% of consumers saw their credit score decline in June, which is slightly lower than May. And 38% of credit scores increased.

Now, while Credit Karma doesn’t use the FICO scoring formula that most lenders use, the trend is interesting because it seems to confirm what FICO has said: Limit cuts are not hurting consumers as much as some have expected, because consumers are reining in their spending, reducing their balance and new purchases.
Some of Karma’s other findings:

• The South as a region had the highest percentage of increasing credit scores, ending the Midwest’s four-month run at the top. In June, 39% of consumers in the South saw their credit scores increase; 28% of credit scores decreased; and 33% of credit scores stayed the same.
• Michigan had the highest percentage of increasing credit scores during June at 41%; 27% of credit scores declined; and 32% stayed the same.
• Texas saw the highest percentage of decreasing credit scores with 29%; 39% of Texas consumers credit scores increased; and 32% stayed the same.

Want to learn more about boosting your credit score? Check out my latest columns:

• 7 fast fixes for your credit score
• Raise your credit score to 740
• New threats to your credit score

Dear Liz: I’m curious about your recent answer to the folks asking about a short sale. In it, you said, “Short sales . . . typically harm credit scores as much as foreclosures do.” As a real estate professional, I am under a different impression.

Certainly, in financial distress, one’s credit score takes a beating, but I don’t believe there is a code or classification for short sales on credit reports. We generally encourage short sales when possible as we feel short sales allow a debtor to get back on their feet quicker. I’d appreciate other data if you have it, as this would change how I educate clients. I do think we may see some changes in the future. As the number of short sales increases, we may see some way to note such transactions on credit reports.

Answer: The information about how credit scores are affected by short sales comes directly from FICO, the company formerly known as Fair Isaac Corp., which created the leading credit scoring formula.

You’re right that the formula has no specific code for a short sale, which is when the lender agrees to accept the proceeds of a home sale as full payment of a mortgage, forgiving whatever additional balance is owed. But most lenders report short sales as a debt settlement, which has a strongly negative effect on credit scores.

In many cases, the borrowers’ scores were already trashed by late payments and by the notice of default, which is filed by a lender after several skipped payments. A settlement notation or a foreclosure just makes a bad situation worse.

But you may have a good point about the debtor potentially being able to bounce back faster with a short sale. The foreclosure process can drag on for months, and sometimes more than a year, with each missed payment causing additional damage to the borrower’s score. Arranging a short sale may help a borrower put an end to the credit damage so he or she can start the long road back to better scores.

Dear Liz: My credit card issuer has informed me that it is closing my account due to inactivity. I’ve been a customer since 1993 and used the account extensively until two years ago, when I decided to get my financial life in better order and stopped charging purchases to this card.

I don’t want to lose this financial resource or have my credit score affected. I talked to an account manager about reopening the account and offered to make a balance transfer with a guaranteed monthly charge for my health club fees, but he said he could do nothing — the bank had made the decision to eliminate inactive accounts.

What can I do to reverse this decision? Whom should I contact at the bank and what should I say?

Answer: Credit card issuers don’t seem to be interested in reopening closed accounts, even for formerly loyal customers.

In the past, issuers were willing to keep these accounts open, hoping you would return. These days, however, credit card companies are trying to reel in lines of credit wherever possible, and inactive accounts are an easy place to do so.

If you have several other credit card accounts, the damage to your credit score is likely to be minimal. If you’re concerned about not having enough access to credit, though, consider opening another account. This, too, can put a ding on your score, but the damage is likely to fade quickly.

If you have any other cards you’re not using, consider keeping them active by using them to pay those health club fees and other monthly costs. Pay the balance in full every month: You don’t need to pay interest to have access to credit and healthy scores.

Dear Liz: I have paid off my credit card bills each month for years, and I am becoming increasingly frustrated with credit card requirements. I canceled an American Express card because a fee was about to be imposed.

Yet most articles on credit cards say that one should never cancel a card. In a recent column in my local paper, you wrote that applying for a new card could ding my credit. So now I can’t cancel a card or get a new one without harming my credit rating? Where is the logic in this? Should I just cancel all of my cards and go back to paying by debit card and checks?

Answer: Probably not, because another thing that can hurt your credit is not using credit. In order to judge your creditworthiness, the scoring formulas need to see how you’ve handled credit in the past. If you stop using credit entirely, eventually your credit reports will stop generating credit scores.

That doesn’t mean you have to carry credit card balances. Using cards as you have been, as a convenience only, is a great way to keep your credit scores in shape without paying unnecessary interest.

You need to keep in mind that credit scoring formulas were designed for lenders, not consumers. Credit scores’ primary purpose is to predict a borrower’s risk of default, and their logic is based on identifying the behaviors that increase that risk.

Because both opening and closing accounts are associated with a higher risk of default, both actions may hurt your scores.

That doesn’t mean you should never open or close an account, but you should do both sparingly and not when you’re in the market for a major loan.

“Closing accounts can never help your credit score, and may hurt it.” I’ve written that sentence over and over in the decade I’ve been covering credit scoring, parroting what I was told by Fair Isaac, creators of the leading FICO credit scoring formula. Each time I’ve updated my book, “Your Credit Score,” I’ve consulted with the company to see if anything’s changed, including that mantra.

But it turns out “never” never actually meant “not ever.”

Fair Isaac, now also known as FICO, recently backed off on its absolute language at MyFico.com when describing the effects of account closures. Turns out that sometimes, “in exceedingly rare situations,” according to a FICO spokeswoman, closure CAN help a score.

But FICO, being FICO, won’t tell us when, how or why.

Here’s what the spokeswoman emailed me when I asked why FICO said closures could never help scores when, in fact, they could:

“In exceedingly rare situations, closing a credit account can cause a person’s score to increase slightly. But because that situation is rare, and because the impact to a person’s score is positive when that situation does occur, and because FICO cannot provide details about that rare exception without disclosing proprietary information, FICO generally tries to remove any ambiguity for the public by explaining that closing a credit card account will never help your score and could actually lower it.”

If you’ve got a copy of my book, please feel free to insert the word “almost” in front of “never.” In the next edition, I’ll do that myself.

Dear Liz: You recently stated that the latest FICO credit-scoring formula, FICO 08, excludes collections under $100. Not so. My 820 credit score was recently dinged by a $65 collection. It dropped my score over 100 points and took me a lot of time to get it removed.

Answer: Not every lender uses FICO 08. When a new version of the FICO formula is rolled out, some lenders adopt it immediately while others may take month or years, or may never do so at all.

The bureaus only started offering FICO 08 to lenders this year, so it’s rather likely that many lenders will still be using the older versions to calculate your scores.

Dear Liz: We bought a house five years ago for $410,000 that is now worth $250,000. Meanwhile, our income in the last year has decreased by about $30,000 annually. We are trying to work with our lender to stay in our house, but things are tight and we don’t know how much longer we will be able to keep making payments on this house.

What would be the downside of doing a short sale, renting for a couple of years until we could buy again? It seems like we would be able to save up while we were renting, and I can’t see house prices doubling in the next two years. What do you think would be our best option?

Answer: You’re right that home prices won’t recover their lost value any time soon. But that alone isn’t good reason to bail on a mortgage, particularly given the fallout such a move can have on your finances.

The damage to your credit will be significant. Short sales — selling a home for less than what’s owed, with the lender’s consent — typically harm credit scores as much as foreclosures do.

And these days it’s harder to recover from a serious credit blow than it used to be. Fewer lenders are willing to take chances on those with subpar credit.

You may be able to qualify for a mortgage again within a couple of years, but you’ll probably pay higher rates for all your credit for several years.

If you can’t work something out with your lender and can no longer afford the payments, you may not have much of a choice. But given the stakes involved, you should explore all your options for saving the house before you turn in your keys.