Protecting your credit score

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You probably know that whether we get a loan or credit card, and the interest rate that debt carries, is largely determined by our credit score. What you may not know is that recent actions by banks may have reduced your credit score even if you carry a reasonable amount of debt and always pay on time.

Recently, many banks have decided to reduce credit limits or close accounts of those whose credit cards are inactive. The banks' perspective is that having a large amount of available credit could lead a person to borrow more than they can repay. Even people who have always been dependable in the past could get in trouble if, for example, they lose a job and take out a large cash advance, or charge daily living expenses to a credit card. The bank might not know trouble was brewing until months later when they fall behind on payments.

Unfortunately, due to the way credit scores are determined, this action is hurting lots of people. One of the factors that is a large portion of your credit score is the "utilization ratio." The utilization ratio compares the amount of outstanding debt to the total available credit. When the bank reduces your credit limit or closes your account, the ratio climbs and the credit score can be reduced.

What steps can you do to protect your credit score from being hurt this way? Instead of using one "preferred" card most of the time and saving others for the potential rainy day, consider rotating cards on a monthly basis. Also, consider opening a new account to keep the available credit high, reducing the ratio. This can help because though recently opened accounts do affect credit scores, they have a lesser effect than the utilization ratio.

Next time, we'll look at the other factors that affect your credit scores. Managing credit scores is no longer as simple as paying your bills on time.

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