Don’t Screw Up Your Credit

Not all mistakes are created equal. Your credit score is determined by five main factors:

  1. Factors That Determine Credit ScorePayment History
  2. Level of Debt/Credit Utilization
  3. Age of Credit
  4. Mix of Credit
  5. Credit Inquiries

Your payment history accounts for one-third of your total credit score.

Your level of debt, measured by your credit utilization, accounts for another third of your credit score. 

The remaining third of your score is determined by the age of your credit, the mix of your credit, and credit inquiries.

Payment History

Because your payment history accounts for such a large portion of your credit score, the following mistakes are the most important ones to avoid.

1.      Paying a bill late or missing a payment 

Late or missed payments can be reflected in your credit report. Some companies (including banks holding your mortgage) will typically give you one “free” late or missed payment before reporting it to a credit bureau, particularly if you’re a longstanding customer with a clean history with them. That said, don’t assume this is the case.

If circumstances prevent you from paying a bill on time, it’s best to contact the company before the due date to make alternate arrangements. If you’re being responsible and proactive in your efforts to keep your account up-to-date (despite having to pay late), most companies will give you some grace and hold off on reporting it. This is an exception to be used only when absolutely necessary – not turned into a habit.

When it comes to credit card payments, remember to make at least the minimum payment on time.  Don’t hold off on making a payment even if it would mean you could make a bigger payment.  Make at least the minimum payment before the due date and then make a second payment when that extra money comes in.  While you may incur interest charges you will keep your payment history intact.

2.      Not paying at all

Sometimes bad things happen or we get in over our heads. If  you’ve been missing payments and it’s become too much to handle, you may be tempted to give up and ignore it, hopelessly pretending it doesn’t exist. Not paying is much worse for your credit rating than paying late. 

3.      Having an account charged off, defaulting on a loan, or having your home foreclosed

What does it mean to have an account charged off? If your account is considered seriously delinquent (e.g. if you haven’t made your payments on time for 6 months straight), a creditor will disable your ability to use further credit on your account, but you’ll still owe the balance. Creditors report charged-off accounts to credit bureaus. This is a serious hit to your credit rating and can stay on your report for 7 years.

Defaulting on a loan is similar to having an account charged off. A default shows that you have not fulfilled your end of the loan contract.

4.      Having an account sent to collections

When a creditor gives up on trying to collect money from you, they’ll send your account to a third-party collector. This can significantly complicate matters for you.

5.      Filing bankruptcy

Filing bankruptcy is absolutely devastating for your credit score. Do whatever you can to avoid this. See a consumer credit counsellor before opting to go this route. It is a last-resort option. Do your research and explore all other options first. Know why a good credit report is important before you impact it negatively to this degree.

There’s still an issue even though a bankruptcy will be removed from your credit report 7 years after discharge.  When a potential lender sees that you have no credit history (and you are old enough that you should be established), they’ll assume that you’ve had a bankruptcy.  It takes several more years of careful credit building to change this.  It can be done, but it doesn’t happen overnight.

6.      Getting a judgment

When the court has to get involved to get you to pay your bills, you receive a judgment. On your credit report, this looks much worse than “simply” not paying your bills. While you want to avoid a judgment completely, a paid judgment is better than an unpaid one, so resolve it as soon as possible.

Debt Level and Credit Utilization

Credit utilization is the percentage of available credit that you’re using on your credit accounts, both individually and in total.

“For example, if your [credit card] balance is $300 and your credit limit is $1,000, then your credit utilization is 30%. To find out your credit utilization simply divide your credit card balance by your credit limit then multiply by 100. The lower your credit utilization, the better. That shows you’re only using a small amount of the credit that’s been loaned to you.” (Source: About Money)

7.      Having high or maxed-out credit card balances

Don’t assume that all will be well as long as you make the minimum payment on your credit card bills. While the credit card company will be happy, your credit score is negatively affected if your balance is staying quite high. Having high credit card balances (relative to your credit limit) increases your credit utilization and decreases your credit score. If your credit card is maxed out, your credit utilization is 100% which is bad for your credit score, even if you’re making the minimum payments on time every month.

Using a majority of your limit but paying it off in full each month can be detrimental to your credit score. Most credit card companies report the balance due at the close of each billing cycle. So even paying the balance in full immediately upon receiving your bill might not reduce your credit utilization on your credit report. (The best practice is to pay your card before the closing date.)

Just because you’ve been approved for a certain credit limit doesn’t necessarily mean you can afford to take on that amount of debt. Taking on too much can quickly lead to long-term debt trouble. Keep your debt to below 10% of your limit (paying it off at the end of every month). Around 30% is considered acceptable in the banking world. Anything over 50% begins to look scary to a potential lender.

8.      Not paying off debt quickly enough

Credit agencies like to see that you can pay off debt in a reasonable amount of time. If you have a credit account that’s been carrying a large balance for many years, the credit agency thinks you might have a problem paying off a loan.

9.      Closing credit cards

Closing out a credit card that has a balance causes your credit utilization to increase to 100% (because your credit limit drops to $0), lowering your credit score. This makes it look like you’ve maxed out your credit card.

Age of Credit

Loyalty counts. The longer your borrowing history, the better your credit score. This is especially true if you’ve been a responsible borrower. 

10. Closing (& opening) credit cards/accounts

Closing old credit cards makes your credit history seem shorter than it really is. History matters.

Applying for a line of credit will show up on your credit report for at least 7 years, even if the account is open for only a day or two. Opening multiple credit card accounts causes lenders to question your loyalty. (There are people who open a bunch of credit accounts, use their credit, and then “skip town”. Naturally, lenders consider this type a very high risk!)

While having credit accounts is important in order to maintain a healthy credit history and score, evaluate each opening/closing and choose carefully.

It’s good to keep older credit as long as the rate makes sense. You only need a couple of credit accounts. Don’t get sucked into every good credit opportunity.

Mix of Credit

The type(s) of credit accounts you have contributes to about 10% of your credit score.

11. Having only credit cards or only loans

When you have only one type of credit account, your credit score could be affected, especially if there is not a lot of information in your credit history.

12. Not using credit cards

You cannot develop a credit history if you don’t have a credit account. Not using a credit card limits the amount of information the credit bureau can provide to determine your credit score. Your credit score tells a potential lender “how good you are at managing other peoples’ money”. Using a credit card wisely, even one with a small credit limit, can be a helpful tool to build your credit history, and subsequently, your credit score.

Credit Inquiries

Whenever you apply for a new credit account, your credit report is checked. Every credit inquiry is recorded on your credit report. This portion of your credit report accounts for 10% of your credit score.

13. Getting too many credit checks

“Some people get multiple credit checks in one year. You might apply for a credit card, buy a car and purchase a house all within 12 months. [This can be a problem.] Credit agencies don’t like when too many people are looking into your background. It raises red flags and questions, mainly, why are you tapping into so much credit in such a short period of time? Two credit checks in one year is fine; three could have a negative effect on your rating.” (Source: Canadian Living

If you’re applying for credit in multiple places, it might appear as though you’re struggling to stay afloat and looking for more available credit to make ends meet.

Getting credit checks for legitimate purposes is okay. But avoid the appearance of shopping around. (What starts as an innocent trip to a department store can result in a quick credit card approval for the advantage of a healthy discount on your purchase. This seemingly simple, easy transaction will affect your credit history.)

Relationship Mistakes

Credit is a personal thing, but our relationships can affect our credit.

14. Assuming your spouse’s credit has nothing to do with yours

Credit bureaus keep a separate score for each individual, but the actions of your spouse can still have an impact on your own credit score. If you have a joint account or loan with your spouse, the activity on that account will be reflected on both your credit score as well as that of your spouse. Even if you have a joint credit card account that only your spouse uses, the payment history of that card will show on your own credit report.

15. Co-signing a loan for a friend or family member

Becoming a co-signer is a gigantic risk when it comes to your credit score.

“The status of that loan will appear on your own credit report. If your co-signee makes a habit of paying late or carrying a high balance, that can negatively impact your score, and there’s no requirement for the bank to inform you about it.” (Source: The Fiscal Times)

Before agreeing to co-sign a loan, you must seriously consider the potential effect on your own credit score. You become legally responsible for paying off that loan if your co-signee defaults. If someone asks you to co-sign, determine if that person is a good credit risk.

One More Mistake

16. Not checking your credit reports on a regular basis.

Errors do happen in the credit reporting process. Anything from a clerical error to identity mix-ups can occur, resulting in unnecessarily bad credit scores. Stay on top of your credit report by requesting a copy of it regularly. (Once a year is the general recommendation.) 

Are you making any of these credit mistakes? Do what you can to restore a healthy credit score, then work hard to maintain it.