Top 5 Credit Score Mistakes
by Aleksandra Todorova
February 16, 2007
WE ALL MAKE MISTAKES. But when it comes to credit, a small misstep — a forgotten payment or closing an unused credit card — can have long-lasting consequences.
A drop in your FICO score, the credit score lenders most commonly use to determine your credit worthiness can result in an increase your interest rates, and if you're shopping for credit, a low credit score can prevent you from qualifying.
Here are the five credit mistakes that can have the biggest impact on your credit rating.
1. Missing a payment
It goes without saying that late payments hurt your credit. What many people don't realize is how much. "Being reported as delinquent in paying your bills is the biggest whammy for your score," says Craig Watts, a spokesman for Fair Isaac, the company that calculates FICO scores. A single late payment could sink you by as much as 100 points, especially if your credit history has been good up to that point. (FICO scores range between 300 and 850; anything 720 and above is considered good.
Ironically, good payers are punished the most. Consider this: A single late payment could drop a 749 score (with no prior late payments on file) by as much as 120 points, to anywhere between 629 and 679, according to Fair Isaac. But if you have a score of 573, with five out of seven accounts having been late or in collections in the past, another late payment won't cause as much hurt. Your score could drop 35 points at most, but could also remain the same.
The bad news: These days, some creditors will report a late payment even if you were only late by a day or two, says John Ulzheimer, president of Credit.com Educational Services. (Most report only if you're 30 or more days late.) To be safe, be sure to pay your bills well in advance, even if you use online bill pay.
2. Maxing out your cards
Guess what: You can have a perfect payment history, never a day late on your cards, and still have a less than average score, says Fair Isaac's Watts. "You could lower your score from an excellent category to a good or fair category simply by using most of the credit available to you," he says. Indeed, maxing out your credit cards could bring your score down from 749 to as low as 609, according to Fair Isaac's FICO Score Simulator.
Again, consumers with already low scores won't be hurt as much. A 573 score that has negatives such as delinquent accounts could drop to 543 if all accounts are maxed out, but could potentially remain the same.
To avoid mistakes, be sure to ask your credit-card companies for the highest limit they'll give you. Contrary to what many people think, a higher credit limit can actually help improve your score.
3. Applying for credit
Applying for credit can be tricky. On the one hand, you need credit cards if you want to build a credit history and have a good credit score. On the other, applying for too many cards too quickly can hurt you. That's because each inquiry (when a creditor pulls your credit report and score to see if you qualify) drops your score a little, says Watts
How much depends on your previous history. Ironically, the more you need to apply for new credit — say you're just starting to build a credit history or you're trying to recover from a bankruptcy filing — the more inquiries will affect your score. "If someone already has significant credit problems on their report and now they're shopping for new lines of credit, that's an indicator that they're a higher credit risk," Watts says. “Same with people with little or no credit because there isn't sufficient information on the report reflecting positive credit management to balance the negative impact of the inquiries”.
What to do? "Take it slow," Watts says. "That's good advice for anyone, but especially if you're trying to recover or are new to credit."
4. Closing credit cards
Many folks think closing unused credit cards will improve their credit score. Quite the opposite: Closing unused accounts in fact decreases your score, Watts says. Why? You're eliminating a chunk of available credit, which then automatically increases your credit utilization, or how much of your available credit you're using. Credit utilization is responsible for a hefty 30% of your credit score, so the effects of closing a credit card with a generous limit could be pretty severe.
How can the simple act of moving affect your credit score? It's simpler than you think. Even if you forward your mail to your new address, bills — including utility bills — can and often do get lost in the shuffle. "Suddenly, someone who's never been late has a collections account reported to the bureaus and the damage would be just as severe as with a delinquency," Watts says. "A $5 library fine could suddenly lower someone's score by dozens of points."
The bad news: You'd think a collections agency would call you about that unpaid bill before reporting it to the bureaus, but that's not always the case, says Credit.com's Ulzheimer. "They'll take the lower-dollar collections accounts and just report them to the bureaus without even contacting the consumer," he explains. "It's easier to report to the bureau rather than wasting time trying to collect $80." Then when you try to buy a house or car and get denied because of the collections account, you'd have to track down the agency yourself and pay up. An efficient business model, to be sure, and all the more reason to be vigilant about paying your bills.
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