Having good credit is easier said than done. Think being responsible and paying your bills on time is enough to keep your credit score high? Think again. When applying for a mortgage or any large loan, your credit score can mean the difference between being approved and denied. Even if you are approved, your credit score determines the interest rate of your loan. If you don’t have good credit, you could end up paying thousands in interest alone. You may think you’re on the right track, but these seven practices can negatively affect your financing and lower your credit score.
1. Maxing Out Your Cards
Whether your credit cards have a limit of $15,000 or $500, if you continually charge until there is no available balance on your card, you demonstrate an inability to manage your spending, which will make an impact on your credit score. To determine your creditworthiness, credit bureaus use a metric called credit utilization ratio, calculated by dividing your total balances by your total credit limit as a percentage. This ratio accounts for 30% of your credit score, and the lower the number, the better!
2. Carrying High Balances
The same principle applies to high balances as it does to maxing out your cards. The higher your balances, the higher your credit utilization ratio will be. If you generally maintain low balances on your cards but carry a high balance at a particular bank, this can affect your credit standing with those creditors. They may be less inclined to offer you a lower interest rate, balance transfer offers, or a credit limit increase if you have a high average balance. Try to keep your credit utilization ratio below 35% on any particular card. The good news is that a high balance will not have a negative impact on your credit forever, as credit bureaus will adjust their calculations as you pay down the balance.
3. Closing Your Oldest Credit Card Accounts
Another factor that can negatively affect your credit score—by 15%, in fact!—is your overall credit history. Credit bureaus look at how long your credit history extends to properly understand your payment habits. Let’s say you decide to close a credit account you opened at 18 years old because you no longer use it. In doing so, you have now shortened the record of your established credit history, which can have a negative impact on your score.
4. Closing a Card with a Balance
If you are faced with an interest rate increase on your credit card you can choose to close your account to avoid the increase. The credit card company will then effectively reduce your credit limit to $0, making your card appear maxed out on your credit report. As a result, you will have reduced your total credit limit while maintaining a balance, ultimately raising your credit utilization ratio. And yes, even once your card is closed, you will still have to pay the balance with interest.
5. Closing Cards with No Balance
It may seem harmless to close a credit card account that you are no longer using and does not have a balance, but this isn’t always the case. This point goes back to the credit utilization ratio. By closing the account, you are essentially reducing the total amount of credit available to you. As a result, the balances you are carrying in relation to your total credit availability will be higher. However, once you acquire more than seven revolving debt accounts, canceling a card may be beneficial, as your FICO credit score can begin to suffer if you attempt to maintain too many accounts simultaneously.
6. Applying for Cards and Loans
If you are trying to build your credit, you may be inclined to apply for credit cards frequently and take advantage of the offers that come in the mail. Each time you apply for a credit card, the company pulls your credit report to determine if you are creditworthy. Each time an inquiry is made, credit bureaus take note, ultimately attributing 10% of your credit score to this factor. Multiple credit inquiries might indicate that you are attempting to take on too much debt. Try to limit your credit inquiries to three or fewer every six months.
7. Not Having Diverse Debt
Finally, credit bureaus look at the type of debt you have to decide 10% of your credit score. You should have at least one installment line of credit, like a mortgage or car loan, along with your revolving lines (i.e., credit cards that prove your ability to manage multiple types of debt).
When managing your credit, you have to be strategic. Proving your creditworthiness means establishing lines of credit and using less than you actually need. High credit scores mean low-interest rates, so when you need to use your available credit, you won’t be paying a premium for it.