We all know that your credit score is a main factor in accessing credit. Whether you want to buy a new car or rent a new apartment, your credit score (as well as income, down payment, employment history, etc.) helps lenders determine how attractive you are as a borrower. The problem is, many of us don't know how our credit scores are calculated or how we may be damaging our all-important credit scores. Even those who pay everything on time can see their credit scores dip. To help, we've put together a list of the most common ways that people end up hurting their credit scores inadvertently. Are you guilty of any of these?
1. Lowering credit limits or closing accounts: It might seem like a good idea; you don't need that credit card anymore or you don't spend anywhere near your credit limit, so you either close the card or lower the credit limit to avoid temptation. In reality, it can affect your credit score negatively. One of the main factors of your credit score is your "credit utilization ratio," which measures your limit-to-balance ratio on your credit cards. As the ratio goes up, your credit score is likely to be negatively affected. Say your total credit limit is $10,000 and your total balance is $1,000. Your credit utilization ratio would be 10%. If you cut your credit limit to $5,000, but your balance remains $1,000, your ratio is now 20%. A higher credit utilization ratio is considered a negative factor because it means that you are using more of your credit limit. Ironically, from a credit score perspective it's great to have the credit limit available, but it's not as great if you're using a higher percentage of it.
2. Holding on to "good" debt: It's a common myth that holding on to debt can actually help your credit score. Because of this, many people only pay the minimum amount due on credit cards each month so that they have some debt to hold on to. This not only hurts your credit score, but it can also rack up extra fees that you don't need to pay. If you are only paying the minimum amount on your credit card every month, lenders might think that you have taken on too much debt and are having trouble paying it off. It's better to pay off the total amount due every month on your credit cards to show that you are using your credit wisely.
3. Not taking on any credit: Many people in their 20s might think it's a good idea to just stay away from credit altogether to avoid bringing down their credit score. The problem is that having no credit can also be a huge detriment to your credit score. For most credit score formulas, this accounts for 15% of your score. The whole point of a credit score is to show that you know how to handle credit. If you have no credit, there is no way for lenders to know whether you can handle debt or not.
4. Only having one type of credit: Along those same lines, only having one type of credit doesn't help your credit score, especially if you have very little of that kind of credit. For most credit score formulas, this accounts for 10% of your score. For example, only having one credit card and no loans or mortgages; or only having school loans and no credit cards. The best way to make sure you are maximizing your credit score is to keep a diverse amount of credit in your credit portfolio, as well as making sure you are paying all of your bills on time.
5. Not checking your credit score regularly: Even if you pay every bill on time and follow all the rules of good credit, things outside of your control can affect your credit score. Lenders can make mistakes. Your identity could be stolen and credit could be opened in your name. If you are not regularly monitoring your credit score, these mistakes and mishaps can drag down your score without you knowing. It's a good idea to check your scores at the very least once a year, or a few months before you think you might apply for a loan or line of credit, to make sure that your scores are where they should be. If you want to monitoring your credit more closely, we review some of the top credit monitoring and identity theft services for consumers, so you can check out the reviews and pick one that works best for you.
Need help with your credit? If you are looking for a way to improve your credit, check out our credit card section, which includes cards for students or people with bad credit. If you want to start monitoring your credit score, we review some of the top credit monitoring sites. Check out our compare page to see which one works for you.
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