The end of an era is upon us. Fraudulent use of other people’s credit history through the use of authorized user accounts will soon be a thing of the past. With that necessary and wonderful improvement, there are side effects that all consumers must be aware of as well.

As anyone who has applied for a mortgage, loan, or credit card can likely tell you, a FICO score is a single number that is used as a measure of your creditworthiness. Recent changes in the formula used to calculate your score will likely have an impact on millions of consumers. Fair Isaac, the company that issues FICO scores, recently announced these changes in response to growing concern over the use of authorized user accounts.

Authorized user accounts, on their surface, are not necessarily bad things. They allow a person with an established credit history to permit another person, perhaps an adult child or a spouse, to use his credit card. The added benefit of this practice has historically been that the authorized user had this account, and the potentially lengthy repayment history, added to his credit report as well. As a result, the authorized user would seem more creditworthy and his FICO score could potentially be increased significantly.

While the idea of a parent or spouse helping to improve the score of a loved one seems honorable, the same system has also been exploited in recent years. Through the fraudulent practice known as piggybacking, unscrupulous companies would charge a fee to have customers with credit troubles added as authorized users of an individual with a strong credit history. Through this method, a person could essentially sell his good credit to someone with poor credit. The person with poor credit wouldn’t actually get to use the credit card of the person with good credit, but the payment history on that card, and accompanying FICO score boost, would be added to their credit report.

The latest changes by Fair Isaac, whose implementation will begin in September and is expected to be complete by the middle of 2008, will totally remove authorized user accounts from consideration in determining the FICO score. Lending Club is pleased to see this important and necessary change occur to eliminate artificial inflation of FICO scores.

The downside of this change is that legitimate authorized users, which are likely the majority of the 60 to 75 million authorized users estimated by Fair Isaac to exist, may also see their FICO scores drop, perhaps significantly. If your credit report contains such an account, now may be the time to begin strengthening your own credit history.

Recently, Maneesh Sethi wrote about ways to maintain a good credit score and he suggested that closing unused accounts could help increase your FICO score. Depending on your situation, this can be good advice. We here at Lending Club felt this topic was important enough to warrant an in-depth examination.

Your FICO score is based on a model that uses any of ten different scorecards depending on the profile of the individual. This is the reason that the impact may be different – it depends on which scorecard is used. However, in general, three major factors contribute to understanding this issue:

1) Length of the borrower’s credit history
2) Amount of credit available to the borrower
3) Number of tradelines (or open credit accounts)

Each of these factors is weighed independently, although the length of credit history generally outweighs credit availability, which in turn generally outweighs the number of credit accounts. So, how should you decide whether or not to cancel a credit card? Here are some issues to consider:

Age of Accounts. Is the credit card the oldest one you have?

If so, generally speaking, you should not close the account. Your credit score weights the length of credit history heavily. Over time, people establish a predictive pattern of how they pay their debts. That pattern has been reliable in predicting who will likely pay and who will likely become delinquent. Therefore, someone with 20 years of good credit history will have a higher score than someone with 5 years of similar credit history.

If the credit card you’re considering closing carries a long history of good credit, and you do not have other credit cards with as long a history, it’s probably best to keep the credit card to maintain that credit history. Otherwise, you may not need to keep this credit card. Read on for more…

Credit Utilization. What is the credit limit on the card you are considering closing? What are the balances on your credit cards?

Credit utilization measures your outstanding credit balances against your total available credit. Above a certain point, the higher the credit utilization on your credit cards, the lower your credit scores will be. Closing your largest credit line account without paying down your debt will raise your overall credit utilization and your FICO score will likely decrease.

Number of Accounts. How many credit cards do you have? How many do you need?

Since Fair Isaac Company, the developer of the FICO credit score, does not disclose the details of its scorecards, we don’t know the exact formula it uses to determine the optimum number of credit card accounts. However, we do know that having too many credit card accounts with balances will lower your score, since you may be over-burdened with debt. On the other hand, having too few accounts will also lower your score since there may not be enough information to demonstrate your creditworthiness. Thus, if you have a lot of credit cards with balances, it may help to cancel a couple of the more recently opened ones.

Scenarios
To illustrate how these factors work together, let’s assume the following scenario: Joe Borrower has 5 credit cards, each with a $4,000 credit limit, giving him a total credit of $20,000. Should he close some accounts? Joe should keep the oldest account, whether he uses it or not. Beyond that:

• Say Joe owes a balance of $12,000, spread evenly over the 5 cards. He should consider keeping all of the accounts open. If he closed one, his credit usage would go from 60% ($12,000/$20,000) to 75% (12,000/16,000), which may lower his score.
• If, on the other hand, Joe only owed a balance of $2,000, he might benefit from closing a card. If he canceled one card, his utilization will be 12.5% ($2,000/$16,000), while reducing the number of open tradelines. This may improve his score.

Conclusion
Your individual situation will determine whether canceling a credit card will improve your credit score. Our general advice is to keep your oldest credit card account open, keep your balances low in relation to your available credit limit, and cancel any underused extra credit cards which may tempt you to overspend.

I was talking with a friend who used to work at a bank, and he gave me a great tip on how to reduce your credit card interest rate.

Simply call up the credit card company and ask for a promotional rate. You'll want to call the number on the back of the card and ask to speak to the retention department. Politely ask the person for a promotional rate and slip into the conversation that you might leave and take your business elsewhere. The representative can easily give you a promotional rate that lasts for one year and can be as low as 1.9%!

Of course having a good history with them will help you argue your case -- being an established customer and having a strong repayment history will work in your favor. Also be aware that you can lose this promotional rate if you are late with just one payment, so now would be an excellent time to setup that automatic bill-pay feature you've been putting off.

It costs credit card companies usually five times as much to attract new customers as it does to retain existing ones. This is why the retention department has a strong motivation to work with you and keep your business. It's also why they can be so difficult when you are legitimately looking to leave.

You should also become informed about what your other credit card options are before calling them to request the promotional rate. Mention the promotional rates their competition is offering. Depending on your current credit card's features, you may want to follow through with the threat and leave if they don't lower your rate. Bankrate has a great tool to help you compare different credit cards to find one that works best for you.

I was talking to my girlfriend a few days ago and asked her what type of credit card she was using. She looked over and said "I don't have one." Aghast, I slowly turned my head towards her with a look of surprise and asked, "Why not?" Her reply: "Because I don't need one."

We all know that college students + credit cards doesn't always equal good. While having too many credit cards isn't a great solution, neither is having none at all. College is the best time to build up your credit. Credit is one of those "check off items" that you will need in the future.

In my previous article, I discussed the breakdown of your credit:

• 15% of your credit is based on the length of time you've had credit
• 10% of your credit is based on the types of credit you have

Up to 25% of your credit is based on how long you have had credit! Having a credit card increases the length of time you have had credit. Having a credit card that isn't maxed out, and that you have paid every month, will increase your credit score phenomenally.

Beyond that, credit is really important to life after college. As soon as students graduate, they need to get an apartment or a new house. Home loans are based on your credit. Many landlords do credit checks before renting out their property. Some employers perform credit checks on potential hires.

The best way to increase your credit is to apply for a credit card, and then only use that card a few times per month. The most important thing is to ALWAYS pay it off in full every month. You can obtain student credit cards directly from most banks with almost no fees (I have a Wells Fargo student credit card, for example). By being careful to make payments and not spending too much, your credit score should be golden when you need it.

To borrow through Lending Club, you need to have a FICO score of at least 640. In order for you to have a FICO score, you first need to start building your credit.

I was reading mobilemoneybanking.com e-mail and they mentioned this report called “Out of Balance: Consumers pay $17.5 billion per year in fees for abusive overdraft loans” written by the Center for Responsible Lending.

I am amazed at that level of fee income for the banks - $17.5 billion. The report goes into overdraft fees, and also mentions that the $17.5 billion in fees was for loans of only $15.8 billion.

Think about that one - the fees are actually greater than the total amount of loans.

Other interesting facts in this study:
• The average fee for overdraft is $34 (on a check or debit card payment of $27!)
• Abusive overdraft loan fees accounted for over 40% of bank and credit union fee income in 2006, up from 27% in 2004
• Some banks change the order of overdraft checks so that more checks are charged an overdraft fee (see the study for a better explanation – pages 6 and 7)

Enjoy the study!

John from Lending Club