Your credit history is essentially your financial report card, indicating how responsible you are with your money. It can impact your ability to get credit cards and loans, and it also determines what kind of interest rates you get. Most people know that it's important to keep their credit score high, but they're not always sure how to do that.
Some people think they're doing themselves a favor by either avoiding credit or opening a bunch of credit cards, but neither approach is the right one. Here are some of the most common financial mistakes that might be hurting your credit more than you think.
1. Making late payments
Everyone knows that paying your bills late or failing to pay them at all is bad for your credit. But it can have a larger impact than you realize. A single late payment can drop a 780 credit score by up to 110 points, according to FICO data. The impact is less severe on lower credit scores, but you can still expect to see a double-digit drop in your score if you miss your payment deadline.
It's important to stay on top of all of your payment due dates. If you're prone to forgetting to send in money, see if you can enroll in autopay, so the money is taken out of your account automatically.
2. Not using credit
If you've never had any loans or credit cards in your name, then you don't have a credit history. This can make it difficult to get a line of credit when you do need one because lenders have no way to judge how responsible you're going to be with your money. If they do agree to lend to you, they'll probably charge you a higher interest rate just to hedge their bets. This can make it more difficult for you to pay back the loan.
Of course, you want to be sparing with your credit, but it is important to use it regularly to develop a strong credit history. It's a good idea to diversify your credit as well. Open a credit card or two and take out a loan when you buy a car or home. Part of your credit score depends on the diversity of the credit accounts in your name, and having several types will boost your creditworthiness. However, credit mix is a relatively small portion of your credit score, so it's not a good idea to take out a bunch of loans you don't need just for the sake of improving your score.
3. Maxing out credit cards
Credit cards give you a spending limit based on your credit score, but it's rarely a good idea to spend up to this limit because it raises your credit utilization ratio, which is a measure of how much credit you're using compared to how much is available to you. A high credit utilization ratio is an indication that you're living beyond your means, and it can make lenders think twice about working with you.
Ideally, you should keep your credit utilization ratio to 30% or less. If your credit limit is $10,000, for example, then you should only spend $3,000 or less each month. Any higher than this, and you may see your credit score begin to drop.
4. Applying for new credit cards frequently
Every time you apply for a new credit card or a credit limit increase, the card issuer will do a hard pull on your credit report to see if you qualify. Hard pulls always cause your credit score to take a slight hit, but the impact will depend on how many there are and how close together they occur.
Most credit scoring models take into account that when you're looking for new credit, you're going to shop around to compare your options. For this reason, any hard inquiries that take place within 30 to 45 days of one another are usually counted as a single inquiry. But if you apply for another credit card after this period, you'll be hit with another hard inquiry, which will lower your score even further.
Be smart about applying for new credit or credit limit increases. If your credit score is under 500, you're probably not going to get approved for a top rewards card, so there's no point in applying. And if you were just denied for a credit limit increase last month, your card issuer probably isn't going to change its mind this month. You should only apply for more credit if you feel confident that you're going to be accepted, and even then, you should try to have multiple inquiries as close together as possible.
5. Closing credit card accounts
Closing credit card accounts can hurt your credit score in two ways. First, it reduces the amount of credit that's available to you, thus lowering your credit utilization ratio. Second, if you've had the card for a while, closing it can shorten the average age of your credit accounts. This can have a significant impact, because about 15% of your credit score depends on how long you've been using credit.
If you're going to close some of your credit accounts, make sure you consider how it will affect your credit utilization ratio and average account age before doing so. If possible, close newer accounts first, as these will have a smaller impact on your average account age.
6. Not checking your credit reports regularly
Everyone is at some risk of identity theft these days, and failing to check your credit score can increase your chances of becoming a scammer's next victim. Your credit report contains information on all active credit accounts in your name. By monitoring them regularly, you can catch any suspicious activity and close those accounts before they can wreak too much havoc on your credit score. But if you're not checking your reports frequently, you may not even realize there's a problem until you apply for a loan and get denied.
The government requires the credit bureaus to provide one free credit report to you each year through AnnualCreditReport.com. You can check them all at once or space them out throughout the year. Keep an eye out for any accounts that don't belong to you, as well as unusual activity on your existing accounts.
If you do spot anything suspicious on your credit reports, contact the credit bureau and the financial institution immediately to alert them of the problem. It's also a good idea to place a fraud alert on your credit report so that other financial institutions know to take extra precautions if they receive a new account application in your name. You may want to alert the Federal Trade Commission and your local police to the crime as well.
Keeping your credit score high is mostly about using your money responsibly and understanding how lenders determine your creditworthiness. As long as you live well within your means and avoid these six mistakes, you shouldn't have any trouble getting a line of credit when you need it.
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