When Saving Can Actually Hurt You


Americans are nudging up their savings rates and getting more careful about borrowing.

This begs a question: If you have some spare cash, should you save it or use it to improve your credit score?

Saving and investing have obvious benefits, providing an emergency reserve for the present and a nest egg for the future. But spending money to improve a credit score can produce long-term benefits, too, making it cheaper and easier to borrow for a car, home or other need.

Saving should probably be your top priority if you do not already have a rainy day fund to deal with a lost job, leaky roof or blown furnace. Most experts say an emergency fund should equal three to six months’ salary.

Once the fund is full, the choices get trickier.

Start by getting your FICO score from the company that produces it, the Fair Isaac Corporation (Stock Quote: FIC) or any of the other suppliers you can find by typing “FICO Score” into your search engine.

Scores range from 300 to 850. Scores over 720 are considered excellent, while those from the high 600s to 720 are good enough to get you most loans, but probably not at the lowest interest rates. It gets harder and harder to borrow as your score falls below the mid 600s.

In an example from Fair Isaac, an applicant with an adequate income and a score of 760 to 850 should be able to get a 30-year fixed-rate mortgage charging 4.67%. With a score of 620 to 639, the same borrower would have to pay 6.259%.

Monthly payments on a $300,000 loan would be $1,551 for the first borrower and $1,849 for the second, a $298 difference that demonstrates the value of having a high score.

A borrower’s payment history is the most important of the five factors determining a score, counting for 35% of the total. Making payments on time should be a higher priority than either saving or building a rainy-day fund. Paying on time will save you the late fees as well as improve your credit score.

The second largest factor in the FICO calculation is the total amount of debt, accounting for 30% of the score. It’s best to keep credit card balances and similar debts below 30% of your credit limit.

Using spare cash to get below that threshold is probably more important than establishing a rainy-day fund, since unused credit is another form of emergency reserve. Also, paying down card debt is probably better than most other investments, because saving 18% on a card balance is like earning 18% in a savings account, which is impossible these days.

The third factor in the FICO score is the length of your credit history, accounting for 15%. There’s no way to use spare cash to improve this factor, but it does pay to remember to keep older accounts active if you decide to pay off balances and close some accounts.

The fourth and fifth factors, each accounting for 10% of the FICO score, are the amount of new credit you have recently added to your accounts and the types of credit you have. The more accounts you open, the riskier you look, and the FICO benefits from a mix of loan types with good payment histories, such as mortgage, car loan and credit cards.

Close unused accounts only if you can keep your total balances to less than 30% of the remaining credit. Don’t open new accounts just to get your balances below the 30% threshold.

—For a comprehensive credit report, visit the BankingMyWay.com Credit Center.

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