Your credit score is a rating that lenders use to help decide whether to approve you for a mortgage, car loan or other credit. Unfortunately, it’s all too easy to send your credit score into a tailspin. All you need to do is make one or more of these seven mistakes.
1. Fail to understand how your credit score is calculated.
The three primary credit reporting bureaus — Equifax, Experian and TransUnion — use formulas that rely on five factors:
- Your payment history: whether you pay all your bills on time.
- The amount you owe: not only the total you owe, but also your debt-to-credit ratio, which compares how much you owe with the amount of credit available to you.
- Your length of credit: how long you have been using credit, including the average age of your accounts.
- Types of credit: your mix of different categories of credit, including revolving accounts (such as a credit card or a retail account) and installment loans (such as a car loan or a home mortgage).
- New credit inquiries you make: the extent to which you recently have applied for new credit or taken on more debt.
If your behavior raises red flags with the credit bureaus in any of these areas, your credit score is likely to take a hit.
2. Pay late.
The main thing a lender is concerned about is whether you can repay the loan. Lenders look for patterns of missed or late payments, and being even one day late on a payment could lower your credit score. The best policy is to pay on time and in full. If you can’t pay in full, pay at least the minimum due on or before the due date.
3. "Max out" your credit card.
Lenders get nervous if your debt-to-credit ratio gets too high. You want to shoot for a ratio under 30 percent. To calculate your debt-to-credit ratio, take your unpaid balance (debt) and divide it by your credit limit (credit). The result is your debt-to-credit ratio.
4. Cancel credit cards without considering the effect.
Canceling a credit card is not always a good option. Closing an account could raise your debt-to-credit ratio. Why? Because the available credit you have shrinks when you close the account, but the amount borrowed stays the same. Creditors like to see borrowers with long, responsible credit histories. If the card you close is one that you have held for a long time and paid on time, you just might be reducing that good part of your credit score.
5. Fail to strike a balance between "paper and plastic."
Make sure you use enough credit to keep your score in good shape. If you decide you pay cash for most purchases, you might actually hurt your credit score. That’s because using a credit card properly can convey responsibility and prudent money management. However, keeping your debt under control is most important. If you need the discipline of using paper over plastic to keep your debt in check, by all means do so.
6. Apply for credit you don’t need.
The more credit inquiries or applications you make, the riskier you will seem to creditors. Apply only for cards you really need, and for purchases that trigger a credit inquiry (like a car) that you are truly serious about.
7. Give up on improving your credit score.
If you have credit problems and don’t make an effort to resolve them, chances are your score will keep going down. There are two things that will eventually help you improve your credit score: making regular payments and the passage of time. Pay at least the minimum on every kind of loan or credit card on time. If this seems overwhelming, work with your creditors to establish a schedule of debt servicing. Let them know you have not given up—and back up your words with concrete action.
Learn more about how your credit score impacts your financial future.
Gerri Walsh is Senior Vice President of Investor Education at the Financial Industry Regulatory Authority (FINRA).
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