Flickr / josemanuelerreCredit can be a tricky thing — some behaviours 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:
They will eventually fall off your credit reports – Information on your credit reports has to follow certain rules as far as how long it can remain on the report. In most cases credit information will remain on your credit files for no longer than seven years from the account’s Date of Last Activity or “DLA.” Your DLA will continue to update each month so long as the account remains open, even if you’re not using it. So, an open account will never reach the seven-year mark because each month your DLA updates to the current month. However, once you close the account your DLA will cease to update and the clock begins ticking. Eventually the account will be removed permanently from your credit reports.
Why is this a bad thing? Because a credit score favours a long credit history, with accounts that you’ve held for many years. The length of your credit history counts for 15% of a FICO score, for example. Consumers with a younger credit history are seen as more risky borrowers than consumers who have had credit for many years. So hang onto those old accounts if you can.
You will hurt your “utilization” measurements – 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 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 your past. There are three ways that missing payments will hurt your credit scores. They are:
- How Frequent are Your Late Payments? – If you miss payments frequently then you will be penalised much 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 subsequent 24 months, it’s very common that they assign more value to how you’ve managed your credit in the most recent two years. If your late payments occurred in the most recent two years, then you are more likely to miss more payments in the next two years. And your score will suffer.
- 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 going 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.
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 will undoubtedly cause your credit scores to go down (as we talked about in Mistake #1), and in most cases, in a big way. This is called “over utilization.” 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 then try your best to keep that percentage as low as possible. 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 lender post the inquiry, and that the inquiry remain on the report for 24 months.
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 are higher credit risks than consumers with fewer inquiries. Thus, the more inquiries you have the more points you will lose on your credit scores. While the exact point value is a closely guarded secret by the credit scoring companies, you should assume that your scores would suffer if you have an excessive amount of inquiries.
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 risk score. A credit risk score is designed to assist lenders by 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, in fact, 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 credit score ahead of time for your own information, the score you get might be different from the score the lender is looking at. This is because every lender has different 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. 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 will mean that you will pay higher premiums or be declined coverage outright.
- 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 who didn’t get it.
- Revenue Potential – Credit card companies also use revenue scoring models to predict whether or not you will use their credit card and, therefore, generate revenue for them.
- Collect Ability – For those of you who have collections on your credit reports you can feel certain that the collection agencies assigned to collect those past due debts are also scoring you to determine whether or not you are likely to repay your collections.
- Bankruptcy Potential – Bankruptcy scores predict the likelihood that you will file for personal bankruptcy. You can assume that if you have a poor bankruptcy score that your credit applications will likely be declined.
- Attrition Potential – These scores predict whether or not you will stop using one card in lieu of another. This is called attrition and it is considered the cancer of the credit card industry. If you have a score that indicates that you are likely to attrite and start using another lender’s credit card then you should expect to begin receiving special bonus offers as an effort by your current credit card company to dissuade you from moving on to another card.
- Fraud Potential – Amazingly sophisticated, these models actually can predict whether or not a purchase you are trying to make with a credit card is 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 have been scored to see whether or not the retailer will accept your credit card.
8. Not Understanding Your Rights Under The Fair Credit Reporting Act
This act, commonly referred to as the “FCRA,” is a list of the rules and regulations that govern lenders and the credit reporting agencies. You should become familiar with your rights — including the legal reasons why your credit reports can be accessed, Your Right to Dispute Your Credit Information and Your Right to a Free Copy of all Three of Your Credit Reports via www.annualcreditreport.com. See the Federal Trade Commission site for more info.
9. Not Knowing that you Have Three Credit Reports and Corresponding Credit Scores
Most consumers understand that they have a credit report. However, most consumers 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 warehouses that store your credit history and sell it to lenders who want to grant you credit. These companies are: Equifax, Experian and TransUnion.
Each of these companies maintains credit files on over 250,000,000 consumers, which they sell to lenders. They do not share credit information with each other since they are competitors. As such, you will likely have a unique credit report and credit score at each of these companies. Do not assume that your credit reports and scores are all the same.
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