Most of us know the major credit issues that will cause your score to drop. For example, we all know that late payments, defaults, bankruptcies, maxing out credit cards, and applying for credit too many times can do serious harm to your credit score.
However, there are a few credit missteps that you might not be aware of. Here are five actions that you should know about which can cause your credit score to drop.
Paying off your car
According to myFICO.com, 10% of your FICO credit score (the score most lenders use) is made up of "types of credit used."
In other words, in order to maximize your credit score, lenders want to see that you can use a variety of credit types responsibly. This includes things like credit cards, mortgages, and loans like car loans and student loans.
So, paying off your car can actually reduce the variety of credit accounts you're using, and lower your score. This can be especially true if your car loan is your only loan account. If this is the case, don't be surprised to see a small drop in your score after you're done paying it off.
Never carrying a credit card balance
Now, we all know that having extremely high credit card balances is no good. However, carrying no credit card balances whatsoever can be harmful to your score as well.
The best bet is to carry a small balance and pay it off shortly after you receive your statement. The average FICO "high achiever" carries a balance equal to about 7% of their available credit line. So, if you have credit cards whose limits add up to $5,000, this would mean a $350 balance.
So, a good strategy might be to charge something small each month, like a meal or a tank of gas. And then leave the purchase on your account until after your statement closes.
Closing an old credit card
If you are like many Americans with credit cards they don't use anymore, it can be tempting to close the accounts, especially if they have annual fees attached.
Before you do this, you should know that your credit score is likely to get (temporarily) dinged: 30% of your score is made up of "amounts owed," which for the most part refers to your balances relative to your total available credit.
By closing an account, you are reducing the total amount of credit available to you, so your utilization rate will increase (if you carry balances).
However, this may be a good reason to take a temporary hit, especially if you have old cards with low limits, high interest rates, and high fees.
Opening a new credit account
The length of your credit history provides 15% of your score, and a big part of this is the average age of your credit accounts. If you open a new account, it brings this average down, which can cause your score to drop in the short term.
Additionally, 10% of your score comes from "new credit," which includes things like credit inquiries and the number of new accounts you've opened recently. Applying for a new credit card or loan can hurt you in both areas.
Not having a mortgage payment
This can hurt your credit score for the same reason paying off your car can -- it reduces the "mix" of credit accounts you have. It can be especially damaging if you don't have any other loans on your credit as well, and are relying solely on credit cards for a good credit score.
I can tell you from personal experience that not having a mortgage payment can drop your credit score by around 20 points or so. It may seem like having a "paid in full" designation on your largest credit account would be a major boost, but the opposite effect is more likely.
Know what makes up your score
The best way to maximize your credit score is by knowing what is factored into the scoring formula. Not everything that helps or hurts your credit is common sense, like paying your bills on time. And, while the actual FICO formula is a closely guarded secret, the general categories of information used are readily available.
Lastly, keep in mind that just because an action such as paying off your student loans can damage your credit score in the short term doesn't necessarily mean that it is not the best decision for you. As always, knowledge is key -- the more you know about credit scores, the better equipped you'll be to weigh pros and cons and maximize your score.
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