If you’re living in the US, your credit score is like your lifeline – something so essential; it determines whether or not you can have access to insurance, a new car or a house. And so, the importance of the credit score can never be understated.
There are however ways in which consumers unknowingly harm their credit scores and end up receiving high interest rates, thanks to the counter-intuitive credit scoring system in the US. This article puts together a list of five things to be careful of if you want to maintain a good credit score. We do this by working our way backwards, by disintegrating FICO credit score components and looking at what affects them.
Source: FICO (Factors that affect the Credit Score)
1. Payment History – Late payments kill your credit score
This 35% chunk of your credit score pertains to timely payments and punishes delinquency. Being late on credit payments, failing to pay at all or consistent payment delays damage your credit score in a significant way. Not paying your credit off is the worst thing you can do to your credit score – because the more you delay payment, the closer you are to having your account charged off (which is when creditors believe you’re not going to pay off your accounts). So steer clear of being charged off and be on time.
2. Amounts owed – Even if you pay on time, a high credit balance is penalized
You may be surprised by a low credit score even though you made all payments on time. Well, unfortunately most creditors penalize people based on high credit balances even if they responsibly pay it off. The reason? It is believed that maintaining high credit balance accounts for irresponsible behavior. So now that you know that, it would be a smart move to stop charging everything on that little piece of plastic.
3. Length of credit history – Old is gold
Scrapping your old credit card for a new one can actually harm your credit score, and this is bad news for the responsible card owner. Because by canceling the card that you’ve had for the longest period of time and on which you’ve been making regular payments, you’re erasing good credit history. So if you must, cancel cards that are newer, the one’s you haven’t really used and that are just having you pay fees on them.
4. New Credit – Multiple credit sources in a short time are looked down upon
FICO uses 40 Reason Scores to tell if you should be given credit or not and almost four of them determine if having multiple credit sources has harmed your score. Although there’s no secret formula to having the perfect number of cards, FICO looks for a healthy credit mix that doesn’t signal any discrepancies. An example would be a mortgage loan, a car loan, maybe a store card or two, three or four MasterCard or Visa cards and a home equity line of credit, or HELOC, for example (Source: CNN Money)
5. Types of Credit used – Never go high on balance transfers
Though credit consolidation options like HELOC and credit balance transfers may seem like the best things to do, you need to exercise extreme caution when doing so. Because though diverse credit sources may reflect positively on your credit score, responsible credit payments are also important, so if you consolidate your credit sources down to a handful, your credit-utilization ratio can be driven down in turn making it detrimental to your credit score. So only consolidate when you have large balances in which case FICO may treat your HELOC as an installment loan rather than a revolving loan.