It can be a shock to discover you don’t have good credit.
So, of course you want to fix it – fast. But what if all that credit climbing wisdom you learned along the way is wrong – or worse, could actually backfire and cause your credit scores to plunge even lower? Before you take action, review these five so-called “wise” credit tips. While we’ve all heard them before, these rules may not be the best advice to follow.
1. The more cards you have, the higher your scores will climb.
The key to credit building, according to Experian’s Director of Public Education Rod Griffin, is less about the amount of cards one has and is more about managing them well. “Keep your balances low, or better still pay them in full each month, and your credit scores will take care of themselves. You only need one or two credit cards to have good credit scores.”
But while responsible cardholders with lots of cards may not notice any negative impact on a credit score when carrying low balances and making on time payments, going on an application binge and opening up a lot of cards at once might put a solid credit history into a tailspin.
“As a general rule, don’t open a large number of credit cards in a short period of time. Doing so could indicate to lenders that you're overly anxious for credit,” says Randy Hopper, vice president of credit cards at Navy Federal Credit Union. Plus, each time a lender checks your credit, your credit score is negatively impacted, so apply sparingly.
2. Checking your credit often will lower your score.
Does checking credit lower your score? It depends on who is doing the checking.
Soft inquiries – when you access your own credit report – shouldn’t make much of a difference on your score, if any, according credit scoring expert Barry Paperno, who served as consumer affairs manager for FICO and consumer operations manager for Experian. But too many hard inquiries will.
A hard inquiry is when you apply for credit and a lender checks your credit record. Typically, a hard inquiry will be generated when you apply for a mortgage or mortgage refinance, a credit card, a personal loan or auto loan. A hard inquiry can also result when a potential employer or landlord checks your credit.
Each inquiry will knock your score down a few points and will stay on your credit report for two years.
Checking your own credit score often, however, is a good thing. There are often errors on credit reports that can be fixed and knowing whether your scores are trending up or down helps keep you on track.
3. Close unused accounts.
We’ve all done it. Fallen prey to an enticing store credit card promotion to help offset the cost of an expensive purchase. After that, you never use the card again. But while it seems to make sense to close unused accounts – like the first one you opened back in those college days – purging old cards could be a mistake.
Hopper says its best to avoid closing any credit card accounts, if possible, "especially your oldest accounts because having a higher average age on your credit accounts positively impacts your credit score."
To back up Hopper’s point, the FICO Score Higher Achiever study, a data report that shows how account history can affect scores, indicates that hanging on to older credit cards tends to improve scores over time.
The report also revealed that for those with a fair credit score (650), the average age of credit accounts is approximately 7 years old, with the average oldest account opened about 12 years ago. Those with excellent credit (800) held credit accounts for approximately 11 years. The average oldest account was opened 25 years ago.
However, there are times when closing a credit card makes sense:
- High annual fees or interest rates.
- You are separating or getting a divorce from someone with whom you share a card.
- You are not going to get a loan any time soon.
- You are too tempted to use the card and would rather focus on improving your finances.
How to offset the potential credit score damage:
Something else to consider: even if the card is canceled, the positive payment you had with the card will stay on your credit report for 10 years.
4. Lower your credit card limits.
While a high credit card limit may temp you to charge too much, requesting a credit limit reduction could actually cause even more damage. That’s because lowering the limit will make it appear you have more debt (at least mathematically) if you carry a balance from month to month and cause an increase in your credit utilization rate.
Credit utilization is the ratio of your outstanding balances on one and all of your revolving credit accounts, usually credit cards, compared to the credit limits on those accounts.
According to Rod Griffin, Experian’s director of education, the lower your utilization rate, the less risk you represent to lenders. “Consumers with high utilization are often using credit to spend more than they make and more likely to default if they take on even more debt," says Griffin in his blog. So zeroing out your balances every month is critical to maintaining a high credit score.
Priyanka Prakas, a finance specialist at Fit Small Business, an educational site for small business owners and entrepreneurs, says the best strategy is to work to decrease your credit utilization.
“You can do that by lowering your outstanding debt, increasing your credit limits, or for the biggest punch, doing both of these things,” says Prakas.
5. Carry a balance every month.
“There is a misconception that you must carry a balance on your credit cards to build credit. If you pay off your balance each month, you are showing that you are responsible and over time, your credit score will increase,” says Steve Repak, a North Carolina-based certified financial planner and author of “6 Week Money Challenge for Your Personal Finances.”
Repak knows first-hand what it’s like to deal with a hefty card balance. Before starting a new career in finance, the Army veteran left the military with $32,000 in the red. He eventually paid it off. Now, he uses his credit card only for fuel and groceries each week. At the end of the billing period, he always pays off the balance in full.
“Our current total debt is the second most important factor when calculating your credit score, which means having $0 debt on your credit card is better than having a $500 balance on your credit card,” says Repak.