Credit can be a tricky thing — some behaviors are obviously harmful to your credit, like paying late (or not at all), or maxing out your cards. But some mistakes aren’t all that obvious, and in fact some actions that might seem beneficial can actually have a terrible impact on your credit. We’ve compiled the biggest mistakes to help you determine what might be killing your credit.
1. Closing Credit Cards Accounts
Some of you may wonder why closing credit cards is number one on this list — even above missing payments. In fact, closing credit cards is almost as bad of an idea to boost your credit scores as missing your payments, but it is also a clear number one on the list of credit myths. It is perhaps the most common piece of misguided advice that consumers are given when they ask, “How can I increase my credit score?” But here’s the reality: Closing credit card accounts will not increase your credit score, even if you don’t use the cards anymore. Here’s why:
A closed account will fall off your credit report sooner than an open one - Lenders and credit reporting agencies have to follow certain rules determining how long information can remain on the credit report. In most cases negative credit information will remain on your credit files for seven years from the date the debt first became delinquent. Positive credit information can remain indefinitely, however, closed accounts in good standing are usually removed from the credit report within ten years after closing. And while credit scores continues to benefit from the positive history associated with an account for as long as it remains on the credit report – open or closed – once that account is removed from the credit report all of that good history is gone.
Why is this a bad thing? Because a credit score favors a long credit history, as the length of your credit history counts for about 15% of a FICO score. Consumers with a younger credit history tend to be seen as more risky borrowers than consumers who have had credit for many years. So hang onto those old accounts if you can by leaving them open.
You will hurt your “utilization” measurements - In the short run this is significantly more important than your closed accounts eventually falling off your credit reports. “Revolving utilization” is the amount of your revolving credit card limits that you are currently using. For example, if you have an open credit card with a $2,000 credit limit and a $1,000 balance then you are 50% “utilized” on that account because you’re using half of the credit limit. This measurement makes up almost 30% of your score, and is almost as important to your credit scores as making your payments on time. As this percentage increases, your credit score decreases.
2. Missing Payments
Missing payments is number two on the list because it doesn’t take a credit expert to tell you that missing payments is a bad thing. It’s common sense, unlike closing a credit card account. The explanation why missing payments is a huge mistake is also fairly obvious. Credit scores look at your credit history to see how you have managed your current and past credit obligations in an effort to predict how likely you are to miss payments in the future. The most powerful “predictor” of future late payments is having missed payments in the past. There are three ways that missing payments can hurt your credit scores. They are:
- How Frequent Are Your Late Payments? – If you miss payments frequently then you may be penalized more severely than someone who misses payments infrequently.
- How Recent Are Your Late Payments? – Since scoring models are designed to predict how you are going to pay your bills in the future, the more recent the late payment, the worse it is for your score. For example, if your late payments occurred in the most recent two years, then statistically you are more likely to miss payments in the next two years than someone without any recent late payments.
- How Severe Are Your Late Payments? – The severity of your late payment also plays a big part in your credit scores. Consumers who have missed payments by only a few weeks and then bring their payments up to date are likely to score better than consumers who have payments that are 90 days past due or worse. If you have late payments, it is in your best interest to do all that you can to bring them up to date as soon as possible.
3. Settling With Your Lender on a Past Due Account
“Settling” is a term used in the consumer credit industry that means accepting less than the amount you owe on an account. For example, if you owe a credit card company $10,000 but you can’t pay them the full amount, then they will likely make you a deal for less than that full amount. They have “settled” for less than the full amount, which is likely much less than you contractually owe them. This may seem like a good idea because you are happy that you didn’t have to pay the full amount. However, the lender will report that remaining amount to the credit bureaus as a negative item. This remaining amount is called the “deficiency balance.” A deficiency balance is considered just as negatively by credit scoring models as any other severe late payments. If you can arrange a deal with your lender so that they will NOT report the deficiency balance then that will be your best course of action. If they will not agree to this, then work to find a way to pay them in full or your credit will suffer for 7 years.
4. Over-Utilization of Your Available Credit Card Limits
Having high balances on your credit cards are likely to cause your credit scores to go down (as we talked about in Mistake #1). In this situation, your best bet would be to use your cards sparingly and pay them down as much as possible each month. If paying your cards off every month is unrealistic, try your best to reduce that percentage as much as possible, and your score should slowly work its way back up. There is no magic target to shoot at, but it’s safe to say that the lower the percentage the better.
5. Excessively Shopping for Credit
Every time you fill out a credit application, you are giving the lender permission to access your credit reports. When they access your credit reports they automatically post what is called an “inquiry.” The inquiry is a record of who pulled your credit report and on what date. Federal law requires that the inquiry remain on the report for 24 months, however, credit scores only look at inquiries less than one year old.
Inquiries are used by credit scoring models to determine whether or not someone is shopping for credit. It is a statistical fact that consumers who have more inquiries tend to be higher credit risks than consumers with fewer inquiries. Thus, the more inquiries you have the more points you may lose on your credit scores.
6. Thinking That All Credit Scores Are the Same
Credit scoring is already a confusing enough topic to understand. Add to the mix that there are as many different types of credit scores as there are soft drinks, and it gets really confusing. The most commonly used credit score is a credit bureau risk score. A credit bureau risk score is designed to assist lenders in predicting whether or not a consumer will pay their bills on time in the future.
There are many different places where consumers can purchase their credit reports and credit scores, however, not all of the scores being sold are the same. On the surface this might not seem like a big deal, but it certainly can be. For example, if you are in the market for a new car and you purchase an “educational” (sold to consumers, but not used by lenders) or other type of credit score ahead of time for your own information, the score you get might be different from the score the lender is looking at. Every lender has different lending standards, so the same score may earn you a good deal with one lender but not with another.
7. Thinking That All Credit Scores Predict the Same Thing
Adding to the confusion in number six above is the fact that there are models that predict other things than general credit risk. Scoring models can be built to predict almost anything including:
- Insurance Risk – That’s right. Some insurance companies use credit scoring models to predict whether or not you are likely to file an auto or homeowner’s insurance claim. A poor insurance score may mean that you will pay higher premiums.
- Response Rates – If you receive pre-approved offers of credit in the mail everyday, it’s not random. You have been selected from hundreds of millions of other consumers to receive that offer because you have a “Response Score” that indicates you are more likely to respond to that offer than someone else.
- Revenue Potential – Credit card companies also use revenue scoring models to predict whether or not you will use their credit card and, hopefully, generate revenue for them.
- Collectability – For those of you who have collections on your credit reports, collection agencies assigned to collect those past due debts may be scoring you to determine whether or not you are likely to repay your collection debt sooner than someone else.
- Bankruptcy Potential – Bankruptcy scores predict the likelihood that you will file for personal bankruptcy. A poor bankruptcy score could cause your credit applications to be declined.
- Fraud Potential – Amazingly sophisticated, these models actually can predict whether or not a purchase you are trying to make with a credit card is likely to be fraudulent or not. What’s even more amazing is that it takes about 2 minutes to complete your check-out at a store, and in this short amount of time you may have been scored to see whether or not the retailer should accept your credit card.
[Related Article: The First Thing You Must Do Before Paying Off Debt]
8. Not Understanding Your Rights Under the Fair Credit Reporting Act
This act, commonly referred to as the “FCRA,” is a list of credit reporting rules and regulations that govern lenders and the credit reporting agencies. You should become familiar with your rights — including the “permissible purposes” under which your credit reports can be accessed, your rights to dispute errors on your credit reports, and your right to a free copy of your credit reports from each of the three credit reporting agencies. See the Federal Trade Commission site for more info.
9. Not Knowing That You Have 3 Credit Reports & Corresponding Credit Scores
Most consumers understand that they have a credit report. However, many do not know that they have three credit reports compiled and maintained by three separate and competing companies called “credit reporting agencies.” These companies are essentially repositories that store your credit history and sell it to lenders and consumers. The three largest of these companies are: Equifax, Experian and TransUnion.
Each agency maintains credit files on more than 250,000,000 consumers. They do not share credit information with each other, so you are likely to have a unique credit report at each of these agencies. In turn, each of these credit reports can be used to calculate many different credit scores. Do not assume that your credit reports and scores are all the same.
If you’re concerned about where your credit currently stands, you can check your three credit reports for free once a year. If you’d like to monitor your credit more regularly, Credit.com’s free Credit Report Card provides you with an easy to understand breakdown of the information in your credit report using letter grades, along with two free credit scores that are updated monthly.