Ask Liz Weston

Get smart with your money

Credit Scoring

Q&A: Personal loan debt vs credit card debt

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Dear Liz: I need to understand how credit reporting agencies treat personal unsecured loan debt versus credit card debt.

I am considering getting a personal loan from a reputable lender to pay down my credit card debt. The amount of my overall debt will still be the same, just in a different category. How will my credit score be affected?

Answer: What you need to understand is how credit scoring formulas treat installment debt (loans) versus revolving debt (credit cards). Credit reporting agencies maintain the credit reports used to create scores — but don’t bless (or curse) particular types of debt.

The personal loan’s overall effect on your credit scores is likely to be positive if you pay the loan on time. What you owe on an installment loan is typically treated more favorably than a similar balance on a credit card.

Installment loans have other advantages: You typically get a fixed rate, rather than the variable one charged on most credit cards, and your balance will be paid off over the term of the loan, which is usually three years. If you stop carrying balances on your credit cards, you should be in much better shape: free of debt with potentially higher scores.

Often the best place to get installment loans is from credit unions, which are member-owned financial institutions that may offer lower interest rates.

Avoid any lender that gives you a high-pressure sales pitch, that offers you a loan if you have bad credit or that pitches debt settlement, which is far more dangerous to your finances than a personal loan.

If the lender tries to tell you about a new “government program” that wipes out credit card debt or tries to collect big upfront fees, you’ve stumbled onto a scam.

Q&A: Credit scores and new accounts

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Dear Liz: My spouse signed up for a store credit card to receive a discount on a large purchase. As she has no strong interest in maintaining a line of credit there, is there a simple way of discontinuing this account without affecting our credit scores, given that we may apply for a mortgage in the near future?

If not, is it critical we maintain some frequency of use on this account?

Answer: First, let’s correct a popular misconception that marriage somehow combines your credit records. Assuming she applied for the card in her name alone, this account won’t show up on your credit report or affect your scores.

Should you apply for a mortgage together, however, her scores could affect the interest rate and terms you get. Opening and closing accounts can ding scores, so it’s best to avoid both when you’re in the market for a major loan.

Issuers vary in their policies on closing inactive accounts, so it’s hard to predict how much activity would prevent the card from being shut down. Typically, though, a small charge every two to three months is enough to keep an account open.

Q&A: Credit freezes

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Dear Liz: Is there a way to lock my credit history and access to prevent the unscrupulous from opening accounts in my name? Maybe I’m rare, but I have enough existing credit cards, don’t have a mortgage and essentially have no debt, and I want to keep it that way. I suspect businesses that make their living issuing credit reports will resist this ability, but I want to do all I can to make it tough for anyone to steal my identity.

Answer: You can lock up your credit reports with what’s known as a credit freeze (also called a security freeze). The three major credit bureaus — Equifax, Experian and TransUnion — have information about how to do this on their websites. You also can find general information about credit freezes on Consumer Reports’ site.

Credit freezes can prevent new account identity theft — someone opening new credit accounts in your name. Lenders typically check credit reports when they get new credit applications. If they can’t access your reports thanks to a credit freeze, they’re unlikely to approve the application.

Of course, the freeze applies to you as well. If you change your mind and want to apply for a new account, you’ll need to temporarily thaw the freeze.

Other entities also check credit reports, so you may need to lift the freeze if you apply for a job, insurance, new utilities or cellphone service. You typically have to pay fees (which range from $2 to $15, depending on your state) to each bureau to lock up your credit and another set of fees to thaw it.

Credit freezes won’t interfere with your ability to use your credit cards or prevent your current lenders from accessing your reports.

Credit freezes also won’t prevent other types of identity theft, including tax refund fraud, medical identity theft and criminal identity theft (which occurs when criminals give law enforcement your information when they get arrested, rather than their own).

Still, credit freezes are a good solution if your identity has already been stolen or you’re at high risk because your Social Security number has been swiped or exposed in a data breach.

Credit bureaus may suggest you put a temporary fraud alert on your reports instead, or pay for credit monitoring or identity theft “protection” (which actually doesn’t protect you against anything but simply offers an early warning if your reports are compromised). A credit freeze is a more secure solution, but you have to weigh the potential hassle and cost against the benefit.

Q&A: Can installment loans help repair bad credit?

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Dear Liz: I am working on paying my bad debt from the past to rebuild my scores. I have one credit card that I pay in full every month, but no installment loan. I recently was given the opportunity to take a car loan with monthly payments I could easily afford. Here is my confusion: Taking on more debt while trying to eliminate past debt is usually not advisable. But I also know creditors like to see both revolving and installment credit. Am I OK taking the car loan to give the “well-rounded use” credit, or should I just put that extra money to pay off my past debt?

Answer: Paying off old bad debts typically doesn’t help your credit scores. If these accounts are now in collections, the damage has been done and won’t be erased by your payments.

And if the accounts are in collections, the money you’re paying probably isn’t going to the creditors you originally owed. Those creditors probably sold your debts to collection agencies for pennies on the dollar. If that’s the case, those collectors may be willing to settle for 50% or less of what you owed the original creditor. If you have the cash to make lump sum offers and you decide to take this route, get written assurance from the collector — in advance and in writing — that any remaining debt won’t be resold to another collector. Also, reserve some cash for the tax bill, because forgiven debt is usually considered taxable income.

You also can request a “pay for deletion,” which means the collection agency stops reporting the collection account to the credit bureaus in exchange for your lump sum payment. Getting rid of the collection could help your scores, but many collectors resist this step.

Now, back to your question. Adding an installment loan such as an auto loan, mortgage or student loan to your credit mix can indeed help rehabilitate troubled scores. The scoring formulas like to see people responsibly handling a mix of credit accounts.

If you decide to take out a car loan, shop around for a lender before you commit. Those affordable payments you were shown could disguise a bad loan — one with a sky-high interest rate, a long repayment period or both. It’s wise to make at least a 20% down payment on any car purchase and to limit the loan term to four years or less.

Q&A: Paying an incorrect bill to avoid a credit hit

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Dear Liz: I was a volunteer for a research study at a local university. It required a blood draw done at the university’s hospital. A month later, I received a bill for the blood draw, which I questioned. I was told it was a mistake and that I was in no way responsible for costs associated with the research study. Because the hospital was installing a new billing system, I was told it would take a while to resolve and not to worry about any bills that would come to my house.

Now, three months later, the hospital has turned the bill over to a collections agency, with the amount due double the original cost. They have given me 30 days to pay up, or they will report the delinquency to the credit reporting agencies.

The university seems unable to fix the problem, especially now that the debt has gone to collections. Should I pay the bill to save my excellent credit rating? Or should I continue to fight the university and now the collections agency?

Answer: To avoid damage to your credit scores, sometimes the best course is to pay a disputed bill and then sue the creditor in small claims court. Since you have some time to fight back, however, you should do so.

The good news is that medical bills are usually placed with collection agencies on assignment. That means the hospital can take back the account if it’s sufficiently motivated to do so. Your task now is to make the hospital motivated — if not desperate — to help you out.

Write a letter outlining the facts as you’ve done here and send it to the head of the research study, the president of the university, the head of the university hospital, your local newspaper columnist and, if you’d like, your congressional representative. It’s outrageous that doing a good deed has put your credit at risk because of a hospital billing department’s incompetence. You need to stop dealing with front-line billing people, who obviously don’t have the power to help you, and bring your problem to the attention of people who can.

Q&A: Will having no debt affect our FICO score?

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Dear Liz: My wife and I have paid off our mortgage, we have no car loans, and we pay our credit card balances completely each month, which means that we basically pay no interest. We have four credit cards that are active and a couple more that are rarely used. My FICO score is currently just above 800. At some point we will need to replace our cars and will need car loans, so our FICO scores will be important. Since we currently have no mortgage, no car loans or any other loans, will our FICO score slowly drop, and will that affect our car loans?

Answer: Paid-off loans typically don’t disappear from your credit reports, at least not immediately. Many lenders continue to report these closed accounts for years, which contributes positively to your scores.

Even if none of these paid obligations show up on your reports, though, your responsible use of credit cards should support your high scores. Just continue to use your cards lightly but regularly and pay off all balances in full.

Since you have time before you plan to replace your cars, consider paying cash for them, or at least making a substantial down payment. It’s typically best to use loans only for assets that appreciate — and cars certainly don’t do that.