What You Should Know About Your Credit Score

April 21, 2010— -- Credit scores can affect many aspects of your life, your ability to get a credit card, a mortgage and even a job.

But there are some surprising things that could hurt the all-important score, "Good Morning America" financial contributor Mellody Hobson explained.

Your credit score is determined by credit agencies that look at how you handle your credit and debt and then run that information through a complex calculation that determines your score.

The credit agencies look at five components when calculating your score: your bill paying history, outstanding balances and debt, how you have managed your debt over time, new credit card accounts and finally the variety of credit you have, such as a mortgage or student loans, and how promptly you handle those different kinds of bills, Hobson said.

But there are some surprising things that can negatively affect your score, such as the Home Affordable Modification Program, Hobson said.

The program is supposed to help you reduce your monthly mortgage payment so you can stay up-to-date and prevent foreclosure. But the problem is when you apply for the modification, your lender essentially tells the three credit reporting agencies that you are having trouble with your mortgage, Hobson said, and therefore people's scores have dropped considerably because of it.

But Hobson said that the possibility of a hit on your credit score should not stop you from applying for a loan modification, because the dip would be much less hurtful than a foreclosure, which could ruin your credit rating and stays on your record for seven years.

Closing a Credit Card Could Hurt Your Score

Closing a credit card could actually hurt your credit score, Hobson said. That is because it changes your credit utilization rate, which is a measure of how much credit you use.

For example, if you have two credit cards, one with a $200 limit and another with a $300 limit, then your total available credit is $500, Hobson said. If you are carrying a $100 balance on the card with the $200 limit, then you are using 20 percent of your available credit, which is your credit utilization rate.

Closing a Credit Card Could Hurt Your Score

Should you decide to close the card with the $300 limit, you are left with the $200 card carrying a balance of $100. But now, according to the credit agencies, you went from using 20 percent of your available credit to using 50 percent, despite the fact that you owe the same amount of money.

However, Hobson did not recommend keeping your extra cards open because of this. She said the temporary hit to your credit score is less harmful than the risk of racking up more debt with the additional cards. Hobson said your credit score may suffer a bit, but should rebound in a few months.

Overdue Library Book and Traffic Tickets Can Affect Your Credit Score?

Yes, it's true, unpaid library fines and traffic tickets can affect your credit score because cities looking for revenue are sending these cases to collection agencies, which will appear on your credit report, Hobson said.

Instead, Hobson suggested paying off your fines as soon as possible, because even if you move, these fines will follow you.

Federal Tax Liens and Your Credit Score

If you owe the government money from this past tax season, it will not affect your credit score unless they file a notice of federal tax lien against you, Hobson said.

However, Hobson said if you signed up for an installment plan with the IRS and you owe more than $5,000 there is a possibility that the IRS can file a notice of federal tax lien, according to credit.com, which will then be noted on your credit report.

Hobson said that should a federal tax lien be filed, the National Taxpayer Advocate says it could substantially reduce your score and it remains on your credit report for seven years after you paid it off.

If you paid your taxes with a credit card, this will not affect your credit score until you carry that debt as a balance because it will then increase your credit utilization, Hobson said. Instead she suggested paying off the full balance on time.

Mistakes on Your Credit Report

Hobson advised everyone to check their credit report every year for mistakes. Inaccuracies on your credit report can drastically lower your score, Hobson said, and could cost you thousands of dollars.

Consumer advocates have said that as many as 80 percent of credit reports have errors, Hobson said, although the credit agencies disagree and say that number is too high. Hobson advised everyone to get a copy of their credit report from each agency, because they could be different.

The easiest way to get a free copy of your credit report is to go to www.annualcreditreport.com. Hobson said you are entitled to one free copy from each of the agencies every year, although you may have to pay a small fee.

Should you find an error on your report you can file a dispute with the credit agencies immediately and get it corrected.

Web Extra Tips from Mellody Hobson

Hobson said that you should not open a credit account at a department store just to get a discount, even if you intend to close it immediately. Opening and closing an account can hurt your credit score twice.

There is a myth that says checking your own credit report could reduce your score, that is false, Hobson said. You should check your credit report at least once a year for errors.

Using a credit counseling service will not lower your credit score, however, Hobson said that recommendations that a credit counselor may advise, such as partial payments, could negatively affect your credit score. If these actions keep you out of bankruptcy, though, it is still the more advantageous choice, Hobson said.

Click here to return to the "Good Morning America" Web site.