Every Sunday, The Simple Dollar reviews a personal finance or other book of interest. Also available is a complete list of the hundreds of book reviews that have appeared on The Simple Dollar over the years.

I was about to review the third edition of Liz Pulliam Weston’s Your Credit Score several months ago when I found out that a fourth edition was forthcoming, so I waited until this new and updated edition was released to write this review. What I found was that the book remained a detailed and useful resource concerning how credit scores work in America.

Part of the challenge of credit scores is that the exact formulas for calculating them remain trade secrets. At best, companies like Fair Isaac issue guidelines on how to improve your credit score, but they don’t tell you exactly how they’re calculated.

Unsurprisingly, this can result in some serious confusion. Even worse, these scores are used for all kinds of things, from determining how trustworthy you are during a job interview process to determining your rates when you buy insurance.

Weston has written a pretty solid concise guide to understanding and navigating this minefield.

Why Your Credit Score Matters
If your credit score is good, banks will want to do business with you. They’ll provide you good rates on things like mortgages and car loans. If your credit score is bad, banks will pretty much avoid you because, to them, you’re not worth the risk. Even if you don’t really care about such things, it’s important to keep tabs on your credit score because it’s often the first way you find out that your identity has been stolen. People open up lines of credit in your name, use them for purchases, and you’re the one holding the bill – not something you want to have happen to you.

How Credit Scoring Works
Your credit score is calculated based on your credit report, which is a compiled document about you listing all of the sources of credit you have, such as student loans, credit cards, car loans, mortgages, and so on. You can get your credit report from the federal government at annualcreditreport.com. Generally, five factors make up your credit score: your payment history (have you been making payments?), how much you owe (do you owe a lot?), how long you’ve had credit (longer is better), your last application for credit, and how many different types of credit you use, and all of these pieces are obtained from your credit report.

FICO vs. “FAKO” – Competitors to the Leading Score
The primary formula used for calculating a credit score is called FICO (short for Fair-Isaac Corporation) and it’s the general formula that’s used for calculating your credit score. Unfortunately, the FICO formula is a trade secret, meaning we don’t know exactly how it works. Some companies offer alternatives to FICO, but none of them have caught on.

Improving Your Score the Right Way
How do you improve your credit score? First, get your credit report, as mentioned above, and then make sure you know what every entry on that report is and that it’s correct. Next, make sure to pay all of your bills on time, and then pay down your debts. Also, if you’re trying to improve your score and you’re carrying any debt at all, it’s probably not a good idea to close any of your credit cards or lines of credit.

Credit Scoring Myths
The biggest myth that goes around about credit scores is that your score will be helped by closing old credit cards or having your credit limits reduced. This actually can hurt your score if you’re carrying any debt because it alters the “how much you owe” element of your credit score, which is based on a comparison of your actual debt versus your credit limit. The closer you are to your credit limits on the whole, the worse off you are. So, if you have a $2,000 debt on a card with a $2,500 limit and another card with $0 debt with a $2,500 limit, you’re utilizing 40% of your credit limit. Not bad. But if you cancel that $0 debt card, you’re suddenly using 80% of your credit limit – not good.

Coping with a Credit Crisis
Many people tend to retreat into their shell when things get financially bad, but that usually just makes things worse. A much better approach is to handle it head-on. Look for ways to free up some cash by selling off things in your closet. Prioritize your payments so that you’re not going to lose your home or your car. Contact some of your lenders and discuss the crisis you’re going through – some lenders will put your debts into forbearance during a job loss or other such situations. Weston discusses credit counseling (and doesn’t give it much of a thumbs-up) and bankruptcy as final options after you’ve tried everything else.

Rebuilding Your Score after a Credit Disaster
Much like dealing with a bad situation, recovering from it also requires you to be proactive. Check your credit report regularly and make sure it’s correct with regards to your current situation. Resolve the bad spots still left on your report. Also, if you have the opportunity, make sure that you get positive things about yourself added to your report. If you have a line of credit that’s not being reported that’s in good shape, try to get that to appear on your report by contacting the company who is offering that line of credit.

Emergency! Fixing Your Credit Score Fast
It’s difficult to get changes made immediately to your report and your score. If you do try this route, you need proof of what you’re saying or else you’re just wasting both your time and their time. A much more reliable route is to focus on the positive change you can make over a month or two by doing things such as paying off as much of your credit cards as possible (improving your ratio, as described above), using your credit cards very lightly, and trying to get positive things added to your credit report.

Insurance and Your Credit Score
Insurance companies use your credit score as an element of determining how much to charge you for insurance, so one of the best things you can do to improve your insurance rates is to improve your credit score. Of course, that’s not the only factor in determining your insurance rates, as things like your deductible amount also influence how much you pay.

Can Bad Credit Cost You a Job?
Employers often use credit scores to help winnow down applicants for an open position, particularly in a poor job market. If an open position has a deluge of reasonably qualified applicants, employers are going to look for reliable and trustworthy people, and like it or not, credit scores are often used as a quick thumbnail to check how reliable and trustworthy people are.

Keeping Your Score Healthy
Pay your bills. Pay down your debts. Have an emergency fund. Have adequate insurance (for example, life insurance for you and your spouse). These things all go a long way toward ensuring that your credit score is healthy for the long haul.

Is Your Credit Score Worth Reading?
Weston’s book focuses in on credit scores like a laser beam. If you ever had any interest in understanding how credit scores work and how they affect your life in more detail, this is absolutely the book to pick up.

Keep in mind, though, that this book hits a home run with the topic at hand, but doesn’t really address much else in terms of personal finance (outside of issues directly connected to the topic), so if you’re looking for more of a full picture, you might want to pick up a different book and look at this one as a supplement.

Check out additional reviews and notes of Your Credit Score on Amazon.com.

Samantha writes in:

I don’t understand why I need credit at all. Credit just gets you into debt and you wind up paying interest to other companies. What’s the point of throwing my money away like that?

Samantha asks a really good question here – and in some respects, she’s spot on. Poor use of credit is a big net loss for people. Because of the interest payments, you lose far more than you gain.

However, there are a lot of upsides to healthy use of credit.

First, a good credit rating helps your insurance rates. Insurance companies use your credit rating as a factor in determining what sort of rate to offer you on homeowners insurance, auto insurance, and life insurance. The higher your credit rating – meaning the more reliable you are at obtaining credit, then paying the bills faithfully – the better you seem as a risk, because people with high credit are statistically more likely to be safe drivers, safe homeowners, and likely to live longer.

Second, a good credit rating helps you with employment options. Similarly, many employers run credit checks on potential employees and, again, are much more likely to hire people with strong credit because it’s a clear indication that they’re reliable.

Third, credit often offers great buyer protection. If you use credit to make a purchase – particularly credit cards – the cards offer a lot of protection against fraud, identity theft, and other serious problems. If you pay cash, you miss out on those protections.

Fourth, a good credit rating helps you with renting. Even if you’ve made the decision to entirely avoid credit and rent until you can write a check for a home, your credit still affects your housing because many landlords – particularly those in charge of higher-end housing – will check the credit ratings of potential renters and will reject (or charge a much higher deposit) people who have no credit or poor credit.

In the end, it pays to have a strong positive credit rating. This does not imply, however, that it’s good to be in debt. You can have a great credit rating without digging yourself into debt. Here’s how.

First, get a credit card. If you have no credit history, you can usually get one with a low credit limit pretty easily. Look for one that has some sort of bonus connected to a retailer you use. If you shop at Target, get the Target Visa. If you shop at Amazon, get the Amazon Visa. If you get all your gas at BP, get the BP card.

Second, use the credit card for routine purchases. If you stop for gas, use your card and pay at the pump. If you’re at the store buying some items you need and would buy normally, use your card for that routine purchase. Other than these events, forget about the card entirely.

Then pay off your bill in full each month. If you stick to just using the card for routine purchases, you should have no problem whatsoever paying off your entire bill each month. Thus, you never incur debt that generates interest.

Instead, you get all the benefits of a positive credit rating – lower interest rates, better job application success, buyer protection on some purchases, and better housing opportunities – plus the benefits of the rewards of a good credit card – discounts at the retailers you already use. Together, these add up to a net positive, and if you’re disciplined enough to keep yourself from using the credit card for purchases you would not make without it, it’s nothing but a positive.

Here’s another way to think about it. Your credit rating is simply the method many businesses use to figure out if you’re reliable or trustworthy. If you are, they see you as having more value – you’re likely to be a better employee, you’re less likely to have insurance claims, and you’re more likely to pay your rent. By avoiding credit, you’re sending no signal at all to them – and thus they’re unable to decide if you’re reliable or not and thus won’t offer you the best rates.

Positive credit helps you in many ways and saves you money consistently. Don’t avoid all credit because of a fear of debt – responsible people can enjoy all the benefits of good credit without the drawbacks of bad debt.

Good luck.

I’ve heard from several high schoolers and early college students asking for advice on how to build up their credit history in a safe and responsible manner. One of them is “Jenna”:

I’m currently a freshman at Washington University. I know I need to build up some good credit for the future, when I have to get a car loan and such, but I don’t know where to start. I’m worried about getting way into debt like some people I know.

Building a positive credit rating was one of the things I did right during my college and early professional years, and it’s paid off time and time again with low insurance rates and good terms on student loans, car loans, and our mortgage.

So how do you go about building a positive credit history if you have never applied for any form of credit?

Knowledge Is Power
The first step is to know exactly what you’re trying to build. Your credit history is merely a summary of all of the places from which you have borrowed money over the past seven to ten years – a credit report is just a detailed listing of this information. There are three companies (credit bureaus) that are in the business of collecting the information for credit reports – Experian, Equifax, and TransUnion.

A credit score is a number calculated based on the information in your credit report. The most common type of credit score is the FICO score. While the exact formula for calculating your FICO score isn’t publicly available, MyFico does provide some basic information about how your score is calculated:

FICO scores are calculated based on your rating in five general categories:
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%

In other words, they provide a template for building good credit – all you have to do is take care of each of those areas.

Step 1: New Credit
The first thing you need to do is actually get some credit. The easiest way for most young people to get is to apply for a credit card – but just a single card.

Depending on the conditions of the credit market (and as I write this in September 2008, the credit market is tight), you might not be able to easily get an unsecured credit card. If that’s the case, save up your nickels and dimes and get a secured credit card. Get one issued by a major credit card issuer – Citi, Chase, American Express, or Bank of America – and make sure that they report this card to the credit reporting agencies. Contact these organizations directly – don’t use any sort of “middle man.” Here’s more information about secured cards, which you should definitely read before getting one.

In fact, getting a secured credit card is a brilliant way for anyone to start building credit, no matter what the conditions. A secured credit card is one where you “secure” the card by paying a specific amount in advance – often $500. Then, whenever you use the card, the bill is effectively automatically paid by the amount you’ve paid in advance. When you receive a bill, you’re actually just replenishing that amount you paid in advance to secure the card.

A secured card has several advantages. First, because you’ve secured it with money, almost anyone can get a secured card at any time. Second, because you’ve already effectively paid the bill, you can’t get into debt trouble with a secured card. Third, because it is a credit card, it helps establish your credit history.

As I mentioned before, you should only open one line of credit at a time, and wait a while before opening a new one. A line of credit includes any reason why you may want to borrow money, from a credit card to a payment plan, from a student loan to a car loan. If you open up several lines in a short period of time, you appear to be a risk to people who would loan you money – in terms of your credit score, the “new credit” portion will go down. So just stick to one line on occasion.

One effective way for a college student to manage this is to get a card exclusively for buying textbooks. Use this card at Amazon or at your school’s bookstore and then put it up until the next time you need to buy books.

You can also begin to build up credit through your student loans, if you’re the primary borrower. You’ll likely need a co-signer in order to get the loan, but that student loan will count on your credit report, establishing your credit history.

Step 2: Payment History
Once you have this line of credit, though, keep the payments up. Don’t be late on a single payment.

Each month, the credit bureaus request the status of your payments from your creditors. Are your payments up to date – or at least less than thirty days past due? If everything is good, it helps your credit score. However, if negative reports start to come through – more than thirty days late, more than sixty days late, in default, and so on – then your credit score will start to take a serious hit and those negative marks will show up on your credit report.

Don’t let it happen. Keep those bills paid.

Step 3: Amounts Owed
It’s never a good idea to charge up those credit cards. You should always strive to keep your actual balance at 30% or less of your credit limit, as that keeps the amount owed under reasonable control.

If you have a secured credit card or a student loan, this part is pretty much automatic, as your borrowed amount is effectively fixed and known. It’s really only a concern if you have something with which you can borrow a varied amount, like an unsecured credit card or a home equity line of credit.

The best method of all is quite simple: never use credit for an impulse buy. If you live by that, you’ll be in much better shape than many people.

Step 4: Length of Credit History
If you follow the first three steps and keep them up over a period of years, your credit will be in good shape. Even better, the longer you keep it up, the better your credit score will be (up to roughly seven years).

What does that mean? Pay the bills, steadily but surely, and keep that first credit card, even if you decide to stop using it, because it establishes the length of your credit history.

I still have my first credit card, tucked away. It has had a zero balance for years, but when I was getting my mortgage (which was manually underwritten), the underwriter actually pointed out that it was a good sign that I was reliable with available credit (even though the balance had been up and down quite a bit in the years preceding our mortgage).

It has a similar positive effect on your score. Keep up the good work – and you’ll be rewarded for it.

Step 5: Types of Credit Used
Another minor factor is the types of credit you have. If your entire credit history is based on unsecured credit cards, for example, you’ll get a small negative mark on your score simply because all of your credit is revolving.

How can you alleviate that? Balance credit cards with other forms of debt, such as student loans or mortgages. Since it’s often much easier to get a student loan, a car loan, or a mortgage if you have already-existing positive credit, getting such a loan and steadily making payments on that as well will further boost your credit.

Remember, though, that the types of credit used is a very minor factor compared to the other pieces of the puzzle. Focus on just getting credit first and keeping it paid. That will be enough to get you in position for things like car loans or student loans, which will provide diversity in the types of credit you have.

Checklist
If I were starting over today in building my credit, here’s what I would do.

1. Get a credit card, preferably unsecured. If I couldn’t get an unsecured one, I’d contact a major bank and attempt to get a secured one.
2. I’d lock the card up in a safe place and only use it for a small number of purchases – it wouldn’t be in my wallet so I wouldn’t be tempted to spend it without reason. I’d also keep that first credit card, even if I zeroed out the balance and stopped using it.
3. I’d pay every bill as it came in.
4. After some time, when it became reasonable in the course of my life, I’d apply for a loan of some sort – a student loan, a car loan, or a housing loan.
5. I’d check my credit report regularly directly from the FTC, not through a middleman operation like freecreditreport.com. If anything incorrect showed up, I’d do the follow up work, contact the credit bureau in question, and get the issue resolved.

Follow those steps and you’ll be fine. Your insurance rates will be lower and when it comes time for big loans, like your mortgage, you’ll be eligible for good rates.

Over the last few days, I’ve received a ton of questions about so-called “hard pulls” and “soft pulls” on your credit report and how they affect your credit score. In order to get the full scoop, I did some extensive research on the subject, and here’s the best information I can find. Let’s start off with the basics.

What’s a credit report?
A credit report is a record of an individual’s history of borrowing and repaying. This includes information about lines of credit, late payments, bankruptcies, credit defaults, and so on.

In the United States, three companies, called credit bureaus, are in the business of maintaining credit reports on each person who obtains any form of credit or debt. These three companies – Experian, Equifax, and TransUnion – effectively operate in the same fashion. They have arrangements with almost every major financial institution to report to them the status of their consumer debts. These companies then collect this information and create reports on individuals, then sell these reports to other companies who are interested in issuing credit or loans.

So, for example, let’s say you have two student loans and no other debt. The student loan companies have shared the status of your loan with the three credit bureaus (this is standard procedure, part of the agreement you signed), and the three bureaus have assembled reports on you containing information about these debts. Then, you apply for a credit card. The credit card holder contacts one (or more) of these bureaus and retrieves your report, showing you have two student loans, how much you owe on each, and whether you’ve kept up with your payments. They’ll use this information to decide whether to issue you that credit card.

Because this information is shared by … well, almost everyone, it’s financially worthwhile to keep your nose clean. All sorts of companies rely on your credit report to determine what to charge you and how big of a risk you are, from insurance to mortgage and car lenders. If you make late payments, sign up for mountains of credit cards, or default on loans, you’re seen as a pretty big risk, and you’re going to be charged more for many services because of it.

Why are there three separate bureaus if they operate in almost the same exact fashion? For starters, the three companies collect and report information largely independently of each other (there is limited data sharing, but not full). This is actually useful for you, the consumer, because if one company makes a mistake, then the other two companies can be used as supporting evidence of an error. If just one company existed, it would be somewhat harder to identify and prove errors.

What’s a credit score?
A credit score is just a single number that summarizes most or all of the information in your credit report. Think of it as an “executive summary” of your credit report – all of the information boiled down to just one number.

How is that number calculated? Each of the credit bureaus uses a slight variation on the same formula, but that formula isn’t publicly known. From Equifax:

Why is my Equifax score different from my Experian and TransUnion credit scores?
There are several reasons for variations in your credit score among the different credit reporting agencies and even among different credit grantors:
+ First, your credit score from each credit reporting agency is based on the information in your credit file at the credit reporting agency, and the credit history information each credit reporting agency has about you can differ. This can result in your score at the other credit reporting agencies being different from your Equifax score.
+ Second, there is a slightly different FICO credit scoring model at each of the three nationwide credit reporting agencies due to the differences in credit history information they each have about you. Remember: your FICO score at a given credit reporting agency is only based on the credit data that credit reporting agency has about you.
+ Third, although the FICO® credit scoring model is the score used most often by lenders, each of the credit reporting agencies, including Equifax, has their own scoring models. These other models may evaluate your credit file differently from the FICO® model and, in some cases a higher score may mean more risk, not less risk as with FICO® scores.

The “FICO” mentioned above refers to the Fair Isaac Corporation, a company that developed a fairly standard method for calculating a credit score. Their methods are in standard use by all three bureaus (with slight variations, as mentioned above) and by all of the other lenders and credit-issuing companies that use these reports.

Surely we must know something about how it’s calculated! Fair Isaac has a very consumer-friendly site about FICO scores called MyFICO, which offers these basic guidelines:

FICO scores are calculated based on your rating in five general categories: Components of the FICO score
Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%

This provides a general recipe of things you can do to keep your credit score high (and your credit report clean).

What’s a “hard pull” and a “soft pull”?
The terms “hard pull” and “soft pull” are very generic terms that describe different features offered by the three credit bureaus. “Hard pull” and “soft pull” each refer to a specific kind of credit report check offered by the bureaus. In general, the big difference is that hard pulls are ones where you’ve granted permission, they indicate that you’re actively seeking credit, they show up on your credit report for everyone to see, and they tend to have a slight negative impact on your credit score. Soft pulls, on the other hand, don’t require your permission, don’t indicate anything about your interest in seeking credit, only show up on the credit report you see, and have no impact on your credit score.

Let’s look at the offerings from each company.

TransUnion refers to “hard inquiries” and “soft inquiries” that generally match the definitions described above. Here’s what they have to say:

What are inquiries?
An inquiry is a record of someone checking your credit information. Inquiries come in two distinct categories: “hard inquiries” that occur when a business views your credit report for the purpose of an application and “soft inquiries” that occur when your credit is checked for other reasons. If you apply for a new credit card, a hard inquiry record will appear on your credit report and may impact your credit. When you check your own credit report, or when it is checked for a pre-approved marketing purpose, it is considered a soft inquiry and will not harm your credit score.

Experian does much the same thing:

Requests by others to view your credit history will show you who has received information from your credit report and who was given your name during the recent past, as allowed by law. According to the Fair Credit Reporting Act, credit grantors with a permissible purpose may inquire about your credit information without your prior consent. This section includes the date of the inquiry and how long the inquiry will remain on your report.

On your personal credit report ordered directly from Experian, information about those who inquired for the purposes of extending a pre-approved credit offer are included for your information. These inquiries are not revealed to creditors and do not impact your ability to obtain credit.

Equifax makes it a bit more confusing:

+ Inquiries are a record of companies and others who obtained a copy of your Equifax credit file. The Fair Credit Reporting Act (FCRA) requires that Equifax disclose to you who requested copies of your credit file. Depending on the reason your credit file was accessed, Equifax generally retains these for one to two years.
+ Some types of inquires you might see on your Equifax Credit Report™ are not reported to others or used in credit score calculations. These include:
– PRM Inquiry. A promotional inquiry in which your name and address were provided to a person who made you a firm offer of credit or insurance, such as a pre-approved credit card offer. These inquiries generally remain on your credit file for 12 months.
– AM or AR Inquiry. An Account Monitoring or Account Review inquiry in which one of your creditors performs a periodic review of your credit file in connection with reviewing your account. These inquiries generally remain on your credit file for 12 months.
– Equifax, ID, ACIS, or UPDATE Inquiry. Internal inquiries that indicate Equifax’s activity in response to your contact with us, for either a copy of your credit report or a request for research. These inquiries will generally remain on your file for 24 months.

To summarize, all three companies allow others to access your report and also record those who access it. A good rule of thumb is whenever you give someone permission to look at your credit report, it will be on your credit report for everyone to see and will give you a slight short-term negative on your credit score. Those are generally referred to as “hard pulls” – anything else (where you didn’t give permission) is a “soft pull” and won’t affect your credit score.

Recently, many banks have begun doing a “hard pull” on your credit report when you sign up for a new savings or checking account (asking for permission in the initial agreement). Not all banks do this (yet), but a sizeable number do.

Another tip: if you’re shopping around for a mortgage or an auto loan, don’t worry about hard pulls. According to Trans Union, the FICO model accounts for this:

You can still shop around for a loan; multiple inquiries for the same purpose in a short amount of time are commonly grouped into one less harmful inquiry session. Inquiries are also helpful for consumers because they can notify you of a potential identity thief applying for accounts in your name.

In general, you shouldn’t worry too much about the occasional hard pull, especially if you don’t have any major loans coming up. The “cost” of a hard pull is slight on your credit score, often not nearly enough to impact anything. You should only worry if you’re applying for a bunch of different kinds of credit very quickly or if you are looking at a major loan in the near future.

What can I do to maximize my credit score?
There are several very basic things you can do to keep your credit high, and the tips come from the components of the FICO score mentioned above:

Payment history – 35%
Amounts owed – 30%
Length of credit history – 15%
New credit – 10%
Types of credit used – 10%

In other words…

Pay your bills on time. Don’t get behind on any of your bills. Pay them on time and make sure that at least the minimum payment is made.

Keep your debts low. Don’t push your credit cards to the maximum. Instead, keep the balances as low as you can.

Keep your oldest credit cards. If you cancel your oldest card, you reduce the length of your credit history. Keep it around with a zero balance in a safe place.

Don’t apply for new credit cards on a whim. For example, if you’re at a store and you’re being offered the store credit card, just say no, especially if you’re going to be using your credit report for something else in the near future.

Having no debt but credit card debt looks bad, too. If you have a bunch of credit cards and no other debts, you look potentially risky. If you are debt free, keep the credit card count low.

A reader sent me this heartbreaking story that I feel I need to share with you all.

I’m writing on behalf of a friend who just graduated from college two years ago and is trying to get on her financial feet. When she was young her mother used her identity several times to get loans and open credit cards. Her mother is a homeless nomad who has not taken responsibility for any of these accounts and has ruined my friend’s credit. She doesn’t even know how many loans and credit cards were obtained in her name, if any are paid of and to what degree, etc. She tries to run her credit report but can’t because she can’t answer the basic questions about her last address or last loan because it’s all her mother’s information.

Her mother has not used her identity for financial gain, that she knows of, in about three years. My friend is trying to be responsible. She has a good job, no debt of her own (just what her mother accrued!), and is trying to live more frugally. She’s been turned down several times for a credit card and obviously, can’t get any other sort of loan. Is there any way to get her mother’s mistakes off her report? It seems like identity theft to me, but I’m not sure how to advise her. Could a lawyer help her clear her report? It doesn’t sound like her mother will be able to pay for any outstanding charges, and I don’t know if suing her would do much good. Since many of these accounts were opened when my friend was under 18, I just can’t believe that she’d be held resposible for all of it. It’s just not fair, and I feel awful for her. Thanks in advance for your help.

Wow, that’s a mess.

First of all, reading stories like these really brings to light how lucky and blessed I was to have two incredibly wonderful parents. If you have a parent out there that loves you, even if your relationship is strained, read that story above one more time and think about giving your folks a phone call. I know I did – I just called my mother and had a good chat with her.

Now, how can this problem be addressed?

The first step I would take would be to contact each credit agency directly and ask them for suggested directions. Explain to them the whole situation, and work with them to work backwards through each of the creditors that have notes on the report.

This is going to be a long process and it will involve a lot of time on the phone. Be prepared for some serious time investment spread out over a long period. Expect to have to escalate this situation regularly, as the person on the phone when you first call probably won’t be equipped to handle this situation. Expect to get some rejections – keep trying and hammering away and escalating.

Second, get some form of credit monitoring service. Once the reports are straightened out, some sort of credit monitoring service needs to be put in place in case any of this happens again.

Third, consider changing your Social Security number. This can be done and is often warranted in cases of harassment – and I’ve got to think (though I don’t know for sure) that this constitutes harassment. Since the person in question is young, they have plenty of time to build up new credit.

Fourth, get involved with political movements pushing for individual credit reform. A big part of this problem comes from the fact that it’s actually quite easy to pretend to be someone else and get easy credit. There needs to be more evidence that credit is being granted to the actual person who the request appears to be coming from, not a paper entity. Identity theft is a real problem and it’s growing.

Finally, don’t give up hope. You didn’t do anything wrong, and anyone who studies your situation will be able to figure that out. Just be patient and realize that this is a sufficiently complex and knotty problem that will take some time to resolve – it won’t all be fixed in a day.

Good luck!

Do readers have further suggestions for this person?

On a fairly regular basis, I suggest to my readers that they cancel unused credit cards except for their oldest one. In fact, I often suggest that you reduce your credit cards to one or two that you use for regular purchases and your oldest one – cancel the rest. This advice is often criticized, so I thought it’d be fair to dig into the issue in some detail.

The “Facts”?

Many people who disagree with this advice point out that one of the elements of a person’s credit score is the debt-to-credit ratio. In other words, the more cards you have, the higher your total credit limit is, and thus your debt-to-credit ratio is better.

From that perspective alone, then it is a bad idea to cancel your cards. But that pulls just one fact out of a big handful of facts. Let’s look at some more.

No one knows for sure how FICO (or other credit scores) work. As I stated in an earlier writeup about credit reports, FICO’s exact formula is a trade secret. They reveal “tips” on how to improve your score and have offered this as general guidance on what makes up your score:

35%,- punctuality of payment in the past (only includes payments later than 30 days past due)
30% – the amount of debt, expressed as the ratio of current revolving debt (credit card balances, etc.) to total available revolving credit (credit limits)
15% – length of credit history
10% – types of credit used (installment, revolving, consumer finance)
10% – recent search for credit and/or amount of credit obtained recently

What do each of those mean? It’s not clear – the best we can do is try to interpret them.

The types of credit used is a factor. If you have a lot of credit cards, you have a lot of sources of revolving credit, the worst kind. That hurts the portion of your score that evaluates the types of credit you’re holding.

Anecdotally, manual underwriters for home loans do not like to see lots of credit cards. When I applied for my home loan, I had two open credit cards – my oldest one and a general use one. The manual underwriter flat-out told me that such a status was a good thing because it showed consumer willpower and less risk that I’d be opening a lot of lines of credit. We ended up getting a very good rate on our home loan.

The more open credit cards you have, the greater the chance of identity theft. Identity theft is a serious concern, and the more open credit card numbers you have floating around at banks, the more likely you are to get bitten by an accident at a bank or unethical use of business records. While this is a small risk, if it does happen, it can be devastating.

A lot of available credit is a psychological temptation. It becomes much easier to just push the plastic and buy something if you have $15,000 in available credit on your cards. If you find it very easy to put purchases on your credit card and worry about the bills later, this is a real concern.

What Does This All Mean?

In a nutshell, it means that there is no definitive and clear answer about what to do. Since the exact formula for credit scores isn’t known, we have to make some guesses about what to do to maximize our credit scores while, at the same time, balancing our other risks.

If your primary goal is to raise your credit score by a few points, you’re probably better off leaving your cards alone for the time being. It keeps your debt-to-credit ratio in a good place, for starters.

However, if you’re a compulsive spender or you’re looking at getting a manually underwritten home loan soon, you should get rid of the extra cards, as other aspects present a greater risk to you.

By default, the best thing you can do is to only have a few cards to begin with and, most importantly, don’t put a lot of money on the cards. That way, your credit-to-debt ratio is good and you don’t have a lot of sources of revolving credit and you don’t have a lot of credit numbers sitting out there, either. Because of that, when people begin paying off their cards and getting into good financial shape, I believe it makes sense to gradually cancel your unused cards.

Whenever you make a significant financial move today that requires financial assistance, it’s often accompanied by a check of your credit report and often a retrieval of your credit score. Lenders (and, quite frequently, other agencies like insurance companies) use this information to help determine a customized offer for you, so it’s quite useful to have an idea of your credit score and to make sure that your credit report is clean, particularly in terms of incorrect statements that can hurt you.

The problem is that there’s no obviously clear way to acquire this information. Credit reports are managed by three credit bureaus (Equifax, Experian, and TransUnion), and these companies make money by selling your credit report and your credit score to lenders. They also hope to make money by selling this information to you, too.

Even worse, there are sharks in the water out there. Programs like freecreditreport.com seek to trick you into signing up for subscriptions to stuff you likely will never use in exchange for your credit report.

Here are the best ways I’ve found to find out your credit report and credit score. Please, if you know of better sources than these, leave a note in the comments.

Getting Your Credit Report

Your credit report is just a listing of all of the accounts and debts that you have and whether you’ve been paying them on time. When you go to get a loan, lenders will use this to see whether or not you’re a reliable person who can be counted on to repay debts. The more reliable you look, the better the rates.

You can get your credit report for free, no questions asked, at annualcreditreport.com. This is a service offered by the FTC that allows you one free download of your credit report each year from each agency (Equifax, Experian, and TransUnion). Since most of the time the three reports are the same, you can effectively grab your credit report for free every four months.

Do not use other services to get your report – you’ll end up being forced to sign up for services and pay fees that you don’t have to pay. The worst offender here is the heavily advertised freecreditreport.com.

Once you have your report, you should read it very carefully to make sure it’s accurate. If you find something that isn’t, start calling. Get ahold of both the credit bureau and the organization that put the false info on your credit report. False information on your credit report does nothing but hurt you and you should seek to get rid of it as soon as possible.

Getting Your Credit Score

Unfortunately, a service like annualcreditreport.com doesn’t exist for one’s credit score. The exact method for calculating credit scores are actually considered to be a trade secret, held by the Fair Isaac Corporation. That’s why credit scores in the United States are often called FICO scores. Thus, you can find out all of the information that makes up your score, but you can’t find the score itself.

The cheapest option is to not find out your specific score. If you’ve checked your credit reports at annualcreditreport.com, you know what your credit report looks like. You can use that information, along with knowledge of your personal finances, and use a FICO score estimator to get a pretty strong estimate of your credit score. I tried this tool and found that it predicted a small range of potential scores – my real score was in fact within that range.

For some, though, an exact number is necessary, and you’ll likely have to pay for that. When I was in the process of shopping for my house loan, I looked at several services and finally used myFICO to get my credit score. They give you several options – the best one, for the long haul, is to get your FICO score from the credit bureau with the worst credit report (you checked them at annualcreditreport.com, right?) for a one time fee of $16. That’s the method I used to find my “worst” score – and it wasn’t bad at all.

There are other options (like getting your FICO score from all three bureaus at once at myFICO, or going to each credit bureau individually), but they’re more expensive. No matter what, though, you should definitely avoid any subscription services – credit monitoring is nice, but you can get the same effect for free by going to annualcreditreport.com regularly.

Now That I Have This Info…

Once you’ve downloaded your credit report, ensured that it’s clean, and figured out your credit score, you can use that information to get realistic assessments of the type of loans you can get. This tool provides a good estimate of the benefits of a strong credit score. With this information, you can make up your own mind about whether you can afford a big purchase right now – or if you need to focus on improving your credit right now.

Remember the biggest rule of thumb: don’t ever sign up for a recurring service unless you’re 100% sure you want it. For credit scores and credit reports, given the strong free and one-time services available, I don’t believe there’s any reason for the average person to sign up for credit monitoring subscriptions. Keep that cash in your pocket instead.

I often get notes from people who have a small mountain of credit cards. They’re trying to figure out which ones they should keep and which ones they should cancel for various reasons, and they’re (rightfully) concerned with their credit report when they do this.

Obviously, a wallet full of credit cards can be a problem: you have many more opportunities for identity theft and, often, with so many credit cards, your total line of credit may be high enough that it’s actually hurting your credit report. This doesn’t even cover the more aesthetic issues: extra paper management, an unreasonably fat wallet, etc.

So, if you have a mountain of cards, what should you do to trim them down? Here’s my recommendation for anyone dealing with a big pile of the cards.

First, identify one to be your primary spending card. There is no universal “best card” for everyone. You should look at your spending very carefully and choose one that best matches your habits. For us, we use the Citi Driver’s Edge card because we both commute for work and we earn a penny per mile driven in the form of a rebate on our next car purchase. It works well for us, but not necessarily as well for others. I actually have a second primary use card – we keep an Amazon card because we do a lot of our shopping there and it nets us 3% back on all purchases there, so we use the Amazon card exclusively for Amazon and the Driver’s Edge card for everything else.

Next, determine which card you’ve had for the longest period of time. Which is your oldest card? That card is the one that has the longest credit history, which is important for your credit report. For me, my oldest card is one that I got as a freshman in college. It has an atrocious “bonus” program associated to it (1/4% return in the form of “points”), but it was the first one I had and thus it’s been on my credit report for more than a decade, establishing that I’ve had positive credit for a long while.

Also, stop carrying this big, fat wallet full of cards with you. I only carry my two primary use cards with me. My oldest card is in my safe. All of the other cards I’ve ever had have been cancelled. This means my wallet is pretty thin, as I basically carry just a very small number of club and buyer rewards cards (library, Sam’s Club, Borders, Best Buy, etc.).

Then, start zero-balancing and cancelling all of your other cards over time. You can pretty safely cancel all of the rest of your cards that already have a zero balance. With the others, stop using them and start paying them off, making minimum payments on all of them and extra payments on whichever one charges the highest interest rate. When that one’s done, cancel it and start making extra payments on the next one and so on until they’re all gone, then cancel them.

What you’ll end up with is a much thinner wallet and a credit report in very healthy shape. The length of your credit history will remain unchanged and the ratio of your credit limit to your income will actually be in better shape than before.