Late payments and accounts turned over to collection agencies aren’t the only ways to sink a credit score. Innocent actions like consolidating debt and even going to the library can torpedo an otherwise good score.
Everyone knows they need to pay their bills on time to maintain a good credit score, but overall credit health depends on more than punctuality. Below are six changes to seemingly innocent habits that can take a credit score from bad to good. Learn how credit utilization ratios, account age, applying for new credit and failure to keep an eye on credit reports can all affect a credit score.
Why a Good Credit Score is So Important
Good credit is absolutely crucial. Why? People with bad credit pay more. They have less options, get stuck with higher interest and have a harder time buying anything from gas to restaurant meals. They might even have trouble getting a mobile phone contract or a job.
The best credit cards with the lowest rates are only available to people with “excellent” credit scores, generally above 750. Those with scores from 700-750 have “good” credit, and pay slightly higher fees and interest rates. The offers get even worse for scores from 640 to 700, in the “fair credit” range. Finally, consumers with scores below 640 have “poor credit.” They merit only the least attractive card offers and the highest fees, if they can get credit cards at all.
Bad Credit Means More Expensive Credit
It’s often difficult for those with low credit scores to get loans for cars or houses. But even when they do manage to borrow, they’ll pay a lot more.
For example, while someone with poor credit may pay interest of 5.5% on a home loan, another borrower with fair credit might pay 5%, and a customer with excellent credit could land a rate of 4%. That means on a $200,000 loan with a 30 year mortgage, the person with the lowest credit score pays an extra $63,000. There are very real and painful costs to not maintaining a high credit score.
For more information on what makes a good credit score, see our article on good credit scores here.
6 Ways to Get a Good Credit Score
There are obvious pitfalls to maintaining excellent credit. Missing payments or giving up on debt entirely so it gets passed on to collection agents are both behaviors that can sink a credit score in very little time.
However, there are also some not-so-obvious ways to boost credit scores. These include:
1. Check Your Free Credit Report Regularly
Each US citizen is entitled to a copy of their free credit report, once per year, from each of the three agencies that compile them. AnnualCreditReport.com is the only website authorized by the U.S. government to distribute these free reports. With the ability to check credit reports for free, there’s no reason consumers shouldn’t monitor their reports.
Check Credit Reports Every Four Months
Although consumers can only get one free credit report per year, there are three bureaus that create them. This means anyone can check a report from one of the three agencies every four months. Also, CreditKarma.com lets users view a summary of their credit report at any time for free.
Why Monitor Credit Reports?
Monitoring credit reports on a regular basis can turn up problems before they cause lasting damage to a credit score. Some things to watch out for and correct include:
- Late payments that have been forgotten about. Catching late payments and paying them before an account is sent to collections can save a lot of trouble. Catching credit report problems early can be the difference between slight damage lasting two years and severe damage that lasts seven years.
- Errors. Even the most conscientious borrower’s credit score can suffer from mistakes by banks or reporting bureaus. Look for accounts you didn’t open, payments you made that are listed as missed and other things you didn’t do that you’ve been blamed for. The three reporting bureaus each have an online form for disputing errors.
- Identity theft. Be on the lookout for incorrect addresses, loans you didn’t initiate and any account you don’t recognize. Someone who opens an account in your name and then abuses it can cause serious damage to your credit score. Catching fraud early can stop it from sinking your score.
2. Keep Your Credit Utilization Ratio Below 30%
A “credit utilization ratio” is the amount of credit in an account vs the amount that’s actually used. For example, a MasterCard with a $3,000 limit that’s maxed out has a credit utilization ratio of 100%, while the same card with a balance of $300 has a ratio of only 10%.
In a survey of 700,000 credit scores by CreditKarma.com, the lower the credit utilization ratio, the better. They found that not only does using only 20% to 30% of available debt correspond to an average credit score of 710, but using 10% to 20% is better, giving an average score of 729. Using 1% to 10% of available debt is best, leading to an average credit score of 745.
It’s important to note, however, that these scores are only averages, and there are many other factors that make up a credit score. Another caveat? Using 0% of available credit can actually hurt a credit score, leading to the dreaded “no credit” designation.
Credit utilization ratios can rise even for those who pay off their card balances faithfully each month. That’s because the ratios are figured from the account’s invoice each billing cycle. A man with a $4,000 credit limit who racks up $2,000 of charges every month but pays them off on time will still have a credit utilization ratio of 50%, even though his account balance at the end of each month is zero.
Credit utilization ratios have a high impact on credit scores, so consumers should do everything they can to keep them down.
- Keep credit utilization ratio down through careful monitoring.
- Pay credit card balances in full before the card company sends a bill.
- People who legitimately use more than 30% of their card limit each month should ask the card company to increase their credit limit.
- Remember that asking for a credit limit hike can also harm a credit score, though if done sparingly the damage will be both slight and temporary.
A Credit Utilization Example
Picture someone named John who travels for business a lot, so he frequently racks up $3,000 in travel expenses. John’s company reimburses him for travel, so he’s not blowing out his budget. John’s Master Card limit is $6,000, which means he’s carrying a card utilization ratio of 50%. Because of this high ratio, his credit score is 690, in the fair credit range. John should ask the card company to raise his credit limit to drive down his credit utilization ratio below 30%.
3. Be Very Careful When Consolidating Debt
It’s a common belief that consolidating debt from many different credit accounts is a good first step to getting one’s financial house in order. Credit card companies even periodically mail checks to customers along with letters encouraging them to make this move.
While consolidating debt makes sense from an organizational vantage point, it can wreak havoc on a credit score. Why? It’s the credit utilization ratio again.
Damaging Debt Consolidation Example
- Card #1 with a $4,000 limit and a $1,200 balance.
- Card #2 with a $3,000 limit and a $900 balance.
- Card #3 with a $2,000 limit and a $600 balance.
Susan has a total of $9,000 of available credit on her cards, and she’s using $2,700. That gives her a credit utilization ratio of 23%, which is a good ratio and will give her a good credit score.
Now she consolidates her debt into the $4,000 card and closes the other two accounts. Common sense would say she’s done a good thing — she’s closed two credit cards and put her debt all in one place. She’s got less temptation, and if the $4,000 card has lower interest than the other two, so much the better.
Not so fast. Now, Susan has one card with a $4,000 limit and a balance of $2,700. That gives her a new credit utilization ratio of 40%. Since she used to have a ratio of 23%, her credit score will go down.
Consolidating debt is not a bad idea, but it’s important to pay attention to the credit utilization ratio when doing it.
4. Avoid Choosing Store Financing on Major Purchases
Store financing plans open a line of credit for the consumer. The limit for the new credit account is the cost of the item being purchased. Store financing on a $1,200 refrigerator, for example, will open a $1,200 line of credit for the purchaser.
What’s wrong with that? The customer automatically has a 100% credit utilization ratio on the store credit account. Store financing is like getting a new credit card, then instantly maxing it out.
5. Avoid Tax Liens and Other Unexpected Black Marks
Maybe it’s not surprising that a tax lien can hurt a credit score. People know that property taxes on homes and cars, local and state taxes and federal taxes should all be paid promptly. If the government decides to place a tax lien on personal property because of unpaid taxes, the lien is entered in the person’s credit history. Derogatory marks from tax liens have a big impact on credit scores.
Someone who thinks they’re immune to tax liens should think again. Even someone who pays their taxes on time every time can fall prey to a lien. Many state governments file liens automatically for missed tax payments even under $100. Something as simple as a single missed letter from the state can stick someone with a lien.
Other unusual items that can cause derogatory marks on someone’s credit history include reports by landlords, unpaid parking tickets and even library fines. Any of these can be turned over to collection agents and hurt a credit score. So, though you may know you need to pay attention to credit card payments, financial responsibility in all areas is the safer bet.
6. Don’t Try to Open too Many Accounts
Attempting to open a lot of lines of credit in a short time is damaging to credit scores. That’s because each time a consumer attempts to open a new account, the financial institution pulls their credit report. Each time a bank requests a copy of a potential customer’s report, that’s called an “inquiry.” Each inquiry made for the purpose of opening a new account is logged in the consumer’s credit report. Too many inquiries will drag down a credit score.
According to Experian.com, new credit accounts should be sought sparingly. The good news is, inquiries don’t stay on a credit report for long, which generally lets the credit score bounce back to normal in a couple months.
A Word on Credit Score vs Credit Report
A credit report is a file of information about a consumer’s past borrowing behavior. A credit score is a number between 300 and 850 created by the three credit reporting agencies, based on an analysis of that information.
The Bottom Line
Many things can sink a credit score — not just late payments and accounts turned over to collection agencies. Keeping an eye on the credit utilization ratio, on the kind and number of credit accounts and practicing sound, responsible debt use and repayment habits can go a long way toward keeping credit scores high. Careful, regular monitoring of credit reports is a great way to measure and maintain the effect of these good habits. In the end, a good credit score means less expensive credit, and that can be a very real financial blessing.
- Credit Card Utilization and Average Credit Scores – Credit Karma