Here's How Much These Common Financial Mistakes Can Hurt Your Credit

Everyone knows that mistakes like paying late, racking up a bunch of debt, and constantly applying for loans can hurt your credit -- but have you ever wondered how much? I turned to MyFICO's Credit Score Estimator tool for some insights. For those who don't know, FICO scores are the most common type of credit score used by lenders to assess your creditworthiness. Your number can mean the difference between a good or bad interest rate, or an acceptance or denial on your next loan.

Of course, it's impossible to pinpoint exactly how much these financial mistakes will hurt you because there are so many individual factors to consider, including your credit limits, the length of your credit history, and the number of red flags on your record. Even the Score Estimator tool can only give a possible range of scores because it doesn't take all of the determining factors into account. However, it can provide some useful insights into how certain actions can affect your credit. Here's what I found.

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The baseline

First, I created three distinct credit profiles and established baseline scores. The first profile is for someone with a good credit history spanning over 20 years. They have a couple of credit cards, but never carry a balance, and they haven't taken out any loans in the last few years. They're conscientious about paying on time and are never in danger of maxing out any of their credit cards, using only about 15% of their allotted credit. This person's starting credit range is 745 to 795.

The second profile is for someone who doesn't have much of a credit history to speak of. They've just gotten approved for their first credit card within the last year, and they've never had any loans in their name. So far, they've been good about making payments on time, and their credit utilization ratio -- the amount of credit they're using versus the amount they have available -- is a little higher than our Good Credit profile, though still below the recommended 30% limit. But because they have such a short credit history, it can be difficult for lenders to assess how they will continue to handle their money. For that reason, their starting credit range is 690 to 740.

The third credit profile is for someone who hasn't been very responsible with money in the past, but is trying to get better. They have a long credit history spanning over a decade, but that history includes a defaulted loan that's still on their record. They still rely heavily on credit in their everyday lives and have several credit cards, a couple of which they carry a balance on. However, they've managed to make their payments on time so far, and their credit utilization ratio is only slightly above the recommended amount at 35%. Their starting credit range is 630 to 680.

Late payments

I then repeated the process for the three credit profiles, only this time, I added in a late payment from two months ago that was 30 days overdue. Here are the results:

Ironically, those with good credit are actually penalized more than those with poor credit. Those with no credit suffer worst of all because they don't have as much of a good payment history to counteract their single late payment. The effects are even worse if you change the 30-day late payment to a 90-day late payment:

The effects of these late payments tend to decrease over time, provided your more recent payment history is good, but it can still take your score years to recover from the damage. Remember that the next time you're thinking about waiting a few extra days to make a credit card payment.

Applying for credit often

Many people may not realize it, but applying for credit regularly can actually hurt your FICO score. Every time you apply for a credit card or loan, the lender will do a hard pull on your credit report. Each hard inquiry knocks a few points off your score, and the effects can compound over time. Here's what happened to each of our three profiles when they applied for five credit cards in the last year:

The difference is not as significant here as it is for making a late payment, but it clearly shows that several hard inquiries can add up. The "poor credit" profile shows only a small change here because it already included two credit card inquiries in its baseline score, so a couple more don't have a significant impact.

You can reduce the effects of these hard inquiries on your score by limiting how often you apply for credit cards and loans. When you are shopping for a new loan or credit card, get all of your credit checks done close together. Hard inquiries that take place within a month of each other are counted as a single inquiry because lenders know this is typical behavior of individuals shopping for new lines of credit.

High credit utilization ratio

As I mentioned above, your credit utilization ratio is the amount of credit you're using compared to the amount that you're entitled to. Ideally, you want to keep that ratio under 30%. That shows that you're living well within your means rather than relying too much on credit, signaling to lenders that you're a low risk. But as that number starts to climb, your risk goes up. Here's how our credit profiles' scores changed when they began using 50% of their total credit limit:

Again, the "no credit" profile shows the biggest change because lenders are unable to determine how the borrower will handle their money over time. Our "poor credit" profile was already over the recommended 30% credit utilization ratio to start with, so raising the amount to 50% didn't change the score dramatically. The difference is a little more pronounced if you up the ratio to 75%:

Each profile's score dropped by an additional 10 to 15 points. For the "good credit" and "no credit" profiles, those 50 or more points could mean the difference between a good credit score and a fair one, or a fair score and a poor one.

Fortunately, there is a pretty easy fix for this. Cut back your spending to make sure that you're not using more than 30% of your allotted credit. If this isn't possible, you may want to see if you can increase your credit limit. This will place a hard inquiry on your report, but the impact of this will be less than that of maintaining a high credit utilization ratio.

The bottom line

These numbers are only estimates, but they provide good examples of how small actions can make a big difference to your credit score. Your score follows you around for life, so it's important to understand the factors that impact it and keep it as high as possible.

Avoiding these three mistakes is a good place to start. Make sure you pay all of your bills on time and that you're mindful of how much credit you're using and applying for. You'll be glad you did when the time comes to refinance or apply for a new loan.