Improve Your Financial IQ – What Hurts Your Credit Score
What hurts your credit score
This is part II of my “Improve Your Financial IQ” four-part series. Part I stressed how important it is to check your credit score. Parts III and IV will cover, respectively, “What helps your score” and “Why do you need good credit?”. Today we’ll look at what causes someone to have negative information show up on his/her report, thus lowering that person’s score.
Your credit report includes a lot of details about you. A previous post has already covered the topic of understanding your credit score. Instead, we’ll look at some specific (and sometimes surprising) facts that can negatively affect your credit score.
Negative records stay on your credit report for 7-10 years
Most negative records (collection accounts, late payments, charge-offs) will stay on your report for seven years. Bankruptcies will stay on your report for 10 years. Information about criminal convictions may be reported without any time limitation. Information about a lawsuit or an unpaid judgment against you can be reported for seven years or until the statute of limitations runs out, whichever is longer. The seven year statute of limitations on information listed on your credit report figures from the date of last activity. A debt can only remain on a credit report for 7 years and 180 days after the delinquency that caused the account to go bad. Sometimes creditors will sell their bad accounts or post information on the credit report to show an activity date that is less than 7 years. THIS IS PROHIBITED.
Paying just the minimum on your credit card balances can hurt you
When it comes to this, there are even cases where individuals that are being charged the highest interest rate in spite of a good credit score, without any warning. The reason is that some credit card companies feel that those who pay only the minimum payment each month are probably doing so because they are overextended. This automatically moves them to the high-risk category.
A late payment on one card can impact all your other cards
45% of the credit card companies out there have universal default policies. Such policies make it possible for creditors to monitor your credit report, looking for late payments to other creditors, and increasing your interest rates should you default on financial commitments with other parties. Under universal default policies, credit card companies can raise your rates if you go over your credit limit on other credit cards. They can also decide you are carrying too much debt in general, and by declaring you as a risky borrower, can raise your rates.
Closing a credit card can hurt your credit score
Doing so affects your debt to available credit ratio. For example, if you owe a total credit card debt of $5,000 and your total credit available is $10,000, you are using 50% of your total credit. If you close a credit card with a $2,500 credit limit, you will reduce your credit available to $7,500. Your credit utilization ratio will jump to 66% of your credit limit, which is generally not good.
There are two exceptions to this rule: if the account was opened within the past two years or if you have over six credit cards. The recommended number of credit card accounts that maximizes your score is between 3 and 5. For example, if a card was opened within the past two years and you have over six credit cards, that account should be closed. If you have more than six department store cards, close the newest accounts. Otherwise, do not close any at all. Credit bureaus like to see a long credit history. To boost your credit score even more, use that old card in your wallet once in a while and then take a few months to pay it off. Again, this shows that you are responsible borrower.
An inactive credit card does not count towards your score
15% of your credit score is determined by the age of the credit file. Fair Isaac’s credit scoring software assumes people who have had credit for a longer time are at less risk of defaulting on payments. Therefore, even if your old credit cards have horrible interest rates, closing those cards will decrease the average length of time you’ve had credit. Use the old card at least once every six months to avoid the account rating to change to “Inactive”. Keeping the card active is as charging every few months, then paying the balance down. An inactive account is ignored by Fair Isaac’s credit scoring software, so you won’t get the benefit of the positive payment history and low balance that card may have. The one thing all credit reports with scores over 800 have in common is a credit card that is twenty years old or older.
Paying a collection account can actually reduce your score
Here’s why: credit scoring software reviews credit reports for each account’s date of last activity to determine the impact it will have on the overall credit score. When payment is made on a collection account, collection agencies update credit bureaus to reflect the account status as “Paid Collection”. When this happens; the date of last activity becomes more recent. Since the guideline for credit scoring software is the date of last activity, recent payment on a collection account damages the credit score more severely. This method of credit scoring may seem unfair, but it is something that must be worked around when trying to maximize your score.
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Next up: What helps your score
Update: a thin credit file is also detrimental to your score. Read the article to find out why.
Update 2: Hiring a credit repair company can hurt your score. Here’s an article on how to find a legitimate credit repair company
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