Bankruptcy

Can No-Limit Credit Cards Hurt Your Credit Score?

By guest-writer

A recent article in the New York Times warns of the potential credit-score harm that a no-spending-limit credit card can have. And, while a credit card with no spending limit may seem like a product that would only be available to folks with strong credit, actually using one might backfire.

How Your Credit Score Works

In order to understand how no-spending-limit cards could hurt your credit score, it?s important to know how a credit score is calculated. Here?s a summary:

• Payment history: Your record of on-time payments is one factor that determines your overall credit rating. Unsurprisingly, timely payments help improve your credit score and late or missed payments can hurt a score.
• Available credit ratio: This refers to how much credit you?re currently using compared to how much you have at your disposal. As a general rule, using only a small percentage of your available credit is best for your credit score; maxing out credit cards or otherwise approaching the limits of what you can borrow is worse.
• Age of accounts: Older accounts are considered ?better? than newer ones because they demonstrate your long-term ability to handle credit.
• Diversity of accounts: This factor refers to what kind of variety you have in your credit sources. It?s best to have credit from various sources (e.g. from a mortgage, a car loan, a student loan, and a credit card rather than just four credit cards). Theoretically, this demonstrates your ability to handle different kinds of credit.
• Credit inquiries: Having lots of credit inquiries on your credit report can damage your score. This is because inquiries happen when consumers apply for a new loan or line of credit. A person trying to take out lots of new credit in a short time is seen as a high credit risk.

How No-Limit Cards Can Affect Your Score

No-limit credit cards play into the ?available credit ratio? factor of the credit score. Depending on how your card issuer reports your account to the bureaus, one of two things can happen:

• The card is reported as an ?open account?: In this scenario, the card issuer reports the account as, essentially, one without a set limit. Because of this, the no-limit card shouldn?t have much of a negative impact on your credit score.
• The card is reported as a ?revolving account?: In this scenario, the card issuer must report an account limit, which usually defaults to your current balance or your highest balance within a certain time period. Naturally, this method of reporting would essentially show your card as "maxed out" at all times - even though you can always take on more debt - and put a significant dent in your credit score .

So how to decide whether a no-spending-limit card is for you? First of all, figure out how your issuer plans to report your account to the credit bureaus. And if it identifies the revolving account technique, you might want to drop that application form.

Full post as published by The Bankruptcy Blog on December 07, 2010 (boomark / email).