Warning! Revolving Accounts May Be Lowering Your Credit Scores

One of the most important ways to achieve and maintain excellent FICO credit scores is to carefully manage your revolving credit.

When I say, "revolving credit," I'm referring to any credit account you have where the monthly payment can vary. Credit cards are the most common form of revolving credit.

Of course, "revolving credit" refers to almost everything in your wallet or purse that's plastic that you can use to buy something. This includes American Express, Discover, MasterCard, or Visa credit cards. This also includes retail store cards such as Macy's or Target, and gasoline cards.

The exceptions are check cards and debit cards. These little dudes may be plastic and have a MasterCard or Visa logo, but they aren't really credit cards. They're more like plastic checks than anything else. Debit cards have nothing to do with your credit scores.

Why your credit reports can show that your credit cards are maxed out when they're not

In my case, my credit scores were lower than they should have been because I was using my personal credit cards for my business. An easy fix...I just applied for a corporate card and began using only that card for anything business related. (You should do the same if you have a small business.)

A few small business leases were also reporting as revolving accounts on my personal credit reports. Those were simple to resolve by just paying the small amounts off.

Then, I did a quick analysis of my credit reports.

The only way to really discover if revolving credit is lowering your scores is to do a quick analysis of your revolving credit accounts. (I'll show you how at the end of this newsletter.) That's how I found the big culprit that was destroying my credit scores...

Beware of home equity lines of credit

When I analyzed my credit reports I got a big surprise...I discovered several of my home equity lines of credit (HELOCs) were being misinterpreted as credit card accounts.

This was fooling the FICO scoring model into thinking that I had an enormous amount of credit card debt. But of course, I didn't.

What I learned was that HELOC accounts can look exactly like a credit card account on your credit reports.

When I was trained by Fair Isaac Corporation, I got a different story. I was told there are two situations when a HELOC won't be mistaken as a revolving credit card:

1. When the original amount of the line of credit is more than $50,000
2. If the account has a narrative attached to it (e.g., equity line of credit or real estate)

Even though Fair Isaac claims the above is true, I didn't find that to be the case with my HELOCs.

It's bad enough that my HELOCs were being mistaken as credit cards...but to make matters worse...all of my HELOCs were maxed out!When a HELOC is mistaken as a credit card, and it's maxed out, then it looks like you have a high-limit credit card and you're using all of its available credit—which lowers your credit scores. Ouch!

My HELOCs were lowering my FICO scores, and it was making it more expensive for me to get personal and business credit. This HELOC issue was a tough nut to crack. We were able to pay off a few of the smaller HELOCs. But we couldn't afford to pay them all off. So we decided to refinance them into home equity installment loans (HEILs).

What's better—a HELOC or a HEIL?

There are a couple of important differences between a HELOC and a HEIL. Once you understand the differences you can strategize on what's best for your credit and financial situation.

Here are the differences:

- A HELOC is a revolving account. This means you can have variable monthly payments determined by the balance you owe each month. A HELOC also allows you to take some or all of the available credit out as you need it...just like a credit card.

- A HEIL is an installment account (just like a car loan or mortgage). This means you'll have the same payment every month until it's paid in full. A HEIL lets you take out only a fixed amount in one lump sum.

- A HELOC could be mistaken as a credit card account by the FICO scoring model because they report as revolving accounts. However, a HEIL cannot be mistaken as a credit card account because a HEIL appears on your credit reports as an installment account.

Because of the effect HELOCs may have on our credit scores, my wife and I are now committed to always using HEILs to tap equity in our properties even though the interest rates are usually higher.

How to protect yourself against holes in the credit system

Here's a strategy you can use to insure yourself against the flaws we've been talking about in the credit system. If you want to tap into your home's equity, apply for the highest HELOC amount you can qualify for. Just don't use more than 10% of the limit. The most essential part of this strategy is your discipline after you're approved. If you can keep yourself from going out and buying things with your new line of credit, you can really protect your credit scores.

This way, even if your HELOC is misinterpreted as a credit card, your credit scores can't be hurt...in fact, it could even help them. So, a HELOC can be a good thing if your balance is extremely low or nonexistent.

My Wake-up Call

Had I not performed a quick revolving analysis of my credit reports—I never would have known my credit scores were suffering because of a simple credit misinterpretation.

Think about all of the things that can lower your FICO scores...late payments...too much credit card debt...too many inquiries, etc.

These are legitimate and understandable reasons why your scores would go down. But to lose points for a silly loophole in how HELOCs are reported is just...irritating.

It goes to prove what I've been teaching for more than 10 years now...having good credit takes more than paying your bills on time. Way more.

Stephen Snyder is the founder of the After Bankruptcy Foundation a non-profit organization that helps people recover after bankruptcy. He has helped thousands of people obtain a credit card after bankruptcy with a fair interest rate.