The importance of maintaining a high credit score is the number one way to secure a healthy financial future. What many people may not be aware of are the negative impacts that innocent actions can have on their score.
Two common errors that are pretty obvious are missing or making a late payment and carrying an excessive amount of debt. But there are other mistakes that you may not be aware you’re doing that adversely affect your credit score.
Cutting Up Credit Cards
Logical as it may sound, avoiding or eliminating your credit cards and paying for everything with cash will not solve a credit score problem. In fact, it will do the opposite. The credit bureaus cannot make an honest assessment of your risk to lenders, if you have little or no credit history to base it on. Financial advisers suggest keeping several accounts minimally active by making a small purchase that can be immediately paid off.
Beware of Lenders of Last Resort
There is a tiered system to borrowing. Non-revolving, secured debt, like a mortgage or car loan, has more value than revolving debt, like a credit card. Farther down the line is a lower tier of debt that is considered lenders of last resort. These loans include local furniture and rent-to-own retailers. The negative reaction on your credit score is partly due to the appearance of a maxed out account that may occur, for example, if your limit is $500 and you use $450, you will have used 90% of your available credit – a bad sign for the credit bureaus.
Closing Unused Credit Cards
It may seem reasonable to close an account when you’ve successful paid off the balance, but don’t do it. The simple act of closing an active account can result in your credit score dropping substantially because the total amount of money you have available to borrow will drop, while you continue to maintain your current amount
of unpaid debt. Available funds compared to your outstanding credit card debt is called the credit utilization rate, which needs to be less than 25% to reap the rewards of an excellent credit score. By closing an account, you could throw off your credit utilization rate, inadvertently lowering your credit scores.
Another factor to consider before closing an unused account is the value of a long credit history, estimated to be 15% of your FICO score. This is another benefit for holding a credit account over many years, even if you don’t use it; closing an older account may be detrimental to your credit score. And while it’s true that a closed
account will continue to be used in the FICO score calculation for ten years, once they are dropped you won’t see the benefit of your credit longevity down the road.
Incorrectly Reported Credit Limit
It has been reported that nearly half of all consumers who use credit have incorrectly reported credit limits with the credit bureaus. This is not a small concern as it impacts the utilization rate by lowering the maximum amount of credit that can be charged, which skews the actual financial condition of the consumer.
While we don’t know all of the particulars that go into making up a credit score, common sense and responsible money management go a long way to secure an excellent one. It’s up to you to keep an eye on your own credit history and immediately report any errors you may find.
Opening A Store Credit Card
Having too many accounts that carry a balance have a negative impact, but more so when they include department store credit cards. Think twice before giving in to the temptation to open an account simply to get a discount on the purchase you’re making. While you may save a few bucks, when the retailer checks your credit report, a hard inquiry will be triggered on your report. Too many of these will put a ding in your credit score.
Depending on your current situation, a hard inquiry may drop your score by 5-35 points. In addition, with the high interest rate that is part of these so called special offers, you may find yourself vulnerable to the temptation of using all that available credit and substantially increasing your debt.
Using a Debit Card to Rent a Car
There are several reasons why renting a car with a debit card is a mistake. When you pay with a credit card, the transaction is covered by the bank and the car agency is confident of being paid. But a debit card payment will require a credit report inquiry, which may result in a drop in your credit score. In addition, you will forfeit any insurance benefits that are offered for credit card purchases when using a debit card, potentially losing valuable travel benefits.