Your credit score is the most important factor in determining your interest rates and creditworthiness. The better your credit score, the less interest you will pay on loans and credit lines throughout your life. Having a good credit score can mean potentially hundreds of thousands of dollars in savings on interest payments throughout your life.
The problem is, the three major credit monitoring companies who determine your score (Equifax, Experian, TransUnion) arrive at that important number via an increasingly complex series of algorithms and other factors. If you can figure out exactly how the FICO score is determined, good for you. You are probably the smartest person in the world. For the rest of you, myFICO is a good resource to learn more and figure out what your credit score is.
Fortunately, there is plenty you can do to improve your credit score without agonizing over that mysterious equation. There are also plenty of things not to do. Here are 8 financial missteps that are guaranteed to damage your score.
1. Late/Missed Payments
A consistent and timely payment history comprises 35% of your credit score. This doesn’t mean that one late payment will completely ruin your credit. What it does mean is that if you make a habit of missing payments / collections or paying late, your score will suffer. In addition, creditors are more than willing to charge late fees and even jack up your interest rate after a few occurrences. So you end up paying for this in two ways: immediate fees for missing the payment, and increased rates on later loans and credit lines. This is common in some of the unfair new credit card fees.
2. Increased Debt/Credit Ratio
If your balances suddenly spike, but you have not been extended a new credit line, watch for a drop in your score. This is especially true if that balance is on a credit card and will not be paid off immediately. The percentage of extended credit you utilize accounts for another 30% of your credit rating. This means that you should be aware of how much credit is extended your way, and keep balances low as much as possible.
Periods of unemployment hit everyone at some point. It is tough. Luckily, there are unemployment benefits to help us get through the tougher times. When getting unemployment benefits, though, remember that it will affect your credit score slightly, which is why you want to receive these benefits for as short a period of time as possible. Credit bureaus do not know that you are on unemployment, but they do recognize the reduction in your income. This may change your ability to pay what is due in a timely manner, which is what will damage your credit score. If this is you, here’s some helpful advice on how to find a job while unemployment rates continue to increase.
4. Too Many Credit Requests
A sudden spike in requests for new credit sends the wrong message to credit bureaus, which will drop your score. This applies most often when applying for more than one line of credit (e.g. HELOC – home equity lines of credit) within a short span of time. For example, if you apply for two credit cards in January, a consolidation loan in March, followed by a car loan in April, you can surely expect your score to plummet. This may only be temporary, especially if you are starting a “new chapter” of your life, but be very aware of how often you apply for new credit.
Note: If you have multiple requests for one type of credit within a short period of time, such as a car loan, it will count as one inquiry.
Also, be aware of different types of credit and how they might impact your score. For example, when it comes to home equity loans, there are differences between home equity lines of credit (HELOC) and home equity installment loans (HEIL). One will often negatively affect your score and the other will not.
5. Private or Government Liens
If you have a lien on any property, it will hurt your credit score. Unfortunately, it does not matter whether the lien is $100 or $100,000. Once the lien is paid off, your credit score will begin to improve, but like bankruptcy, liens will stay on your credit report for 7 to 10 years. If the lien is not imposed by the state or federal government, you can petition credit bureaus to have the lien removed. It is rare, but still worth a try to have it taken off.
6. Ignoring Financial Responsibilities
Obviously, ignoring loans and lines of credit will hurt your score. But how do unpaid cable, utility and medical bills affect your score? The answer is: poorly. Most of these companies do not report for regular payments, but you can bet that if you become delinquent, your credit will suffer. If necessary, set up a payment plan with these companies to avoid negative impact. For many of these companies, good faith is enough to keep your score safe. Keeping in contact with representatives is one of the easiest and most important things you can do if you are having trouble with bills.
7. Closing Cards With Remaining Balances
You may think that getting that credit card off your record is good for your score, but that is not usually the case. In fact, if you have a significant balance left on the card, closing that card will take a toll on your credit score. Since a portion of your score is determined by the overall credit extended to you, removing this card from the equation also removes a chunk of credit granted to you, thus damaging your score. For example, let’s say that between your loans and lines of credit, your total available credit is $22,000. If $12,000 of this available credit is used, and $5,000 of it is from the card you are closing, your available credit drops from $22,000 to $17,000. That would probably be a good thing if the card had no balance, but if the card you are closing is “maxed out,” your used credit remains at $12,000. This sudden increase in your debt/credit ratio (from 54.5% to 70.5%) will drop your score noticeably.
8. Ignoring Potential Inaccuracies
Failure to check your credit report and fix errors could end up hurting your score as well. They may think they are all-knowing and all-seeing, but even credit reporting agencies make mistakes. These mistakes could end up costing you thousands of dollars unless you are proactive enough to catch them and correct them. It is simple and free to check your credit reports once per year, so do not let this responsibility slip.
It is up to you to make sure that your credit report is accurate and in good standing. Failure to do so can give you years of headaches and potential money problems down the road.
So do yourself a favor and avoid doing anything that can damage your financial reputation. Remember, it follows you wherever you go.
(photo credit: Shutterstock)