Your credit score is one of the more important ways to measure the state of your finances, and it’s a number that can impact your ability to qualify for personal loans, credit cards, or even rent an apartment. A higher credit score can open doors to certain financial opportunities, while a lower score can make it challenging to qualify for credit or at the very least, have it come with higher costs. Because of this, it's essential to understand the factors that can harm your credit score and take steps to mitigate them. Today, we’re going to look at a few key aspects that could potentially impact your credit score and then give you some tips on how to potentially improve and maintain a healthy credit profile.
1. Late or Missed Payments
One of the most significant factors that can impact your credit score is late or missed payments on your credit accounts. Payment history makes up a substantial portion of your credit score, and consistently making late payments or missing them altogether can have a severe impact. To avoid this pitfall, set up reminders for due dates and automate your payments whenever possible.
2. High Credit Card Balances
Carrying high credit card balances relative to your credit limits can also impact your credit score. This is known as credit utilization, and it accounts for around 30% of your credit score. Ideally, you should aim to keep your credit utilization below 30%. High credit card balances can signal financial instability and make some lenders wary of extending you more credit. To address this issue, pay down your credit card balances as quickly as possible and avoid maxing out your cards.
3. Applying for Too Much New Credit
Often, when you apply for a new credit card or loan, the lender performs a hard inquiry on your credit report. Multiple hard inquiries within a short timeframe can impact your credit score. Applying for too much new credit can suggest that you may be in financial distress or that you're planning to take on significant debt, which can make lenders hesitant. To mitigate this, be cautious about applying for new credit unless you genuinely need it.
4. Closing Old Credit Accounts
Closing old credit accounts can harm your credit score by reducing your overall credit history length and potentially increasing your credit utilization. The length of your credit history accounts for about 15% of your credit score. Instead of closing old accounts, consider keeping them open to build your credit history. Just keep in mind that you’ll need to consider how big the fees are on these old accounts and if it’s worth the cost of keeping them open.
5. Defaulting on Loans
Defaulting on a loan, like an installment loan or a line of credit, can severely impact your credit score. A loan default remains on your credit report for several years and can make it hard to access new credit during that time. Before taking on credit, make sure you have a clear plan to pay off your debt and avoid taking on more than you can afford to repay.
Filing for bankruptcy is one of the most impactful events for your credit score. It stays on your credit report for several years and can severely limit your ability to access credit. While bankruptcy may be the best option for those facing overwhelming debt, it's essential to consider alternatives and consult with a financial advisor before taking this step.
7. Co-signing for Others
Co-signing a loan or credit card for someone else means you’re equally responsible for the debt. If the primary borrower defaults, it can harm your credit score as well. Before co-signing, carefully consider the risks involved, and ensure you trust the primary borrower’s ability to make all their payments on time.
8. Errors on Your Credit Report
Mistakes can happen, and your credit report is no exception. Errors on your credit report, like inaccurate account information or fraudulent accounts, can impact your credit score. It's essential to regularly check your credit report for inaccuracies and dispute any errors you find. You can get a free credit report from each of the major credit reporting agencies (Equifax, Experian, and TransUnion) once a year, or you can sign up for a credit monitoring service to receive regular updates.
9. Not Using Credit
While excessive debt can impact your credit score, having no credit history can also have an impact. Lenders and credit reporting agencies need a track record of your responsible credit usage to gauge your creditworthiness. If you have no credit history, consider starting with a secured credit card or a credit-builder loan to establish credit history.
10. Ignoring Your Credit Score
Neglecting your credit score can also be harmful. Regularly monitoring your credit score can help you catch issues early and take steps to address them. Many online services offer free credit score monitoring, making it easy to stay informed about your credit health.
11. High Debt-to-Income Ratio
Your debt-to-income (DTI) ratio is a crucial factor that a lot of lenders consider when evaluating your creditworthiness. It's calculated by dividing your monthly debt payments by your monthly income. A high DTI ratio can suggest that a significant portion of your income is already committed to debt obligations, making it riskier for lenders to extend you more credit. To potentially impact your credit score, work on reducing your DTI by paying down existing debts and avoiding new ones.
12. Frequent Balance Transfers
Frequent balance transfers between credit cards can impact your credit score in a couple of ways. Each transfer may result in a hard inquiry on your credit report, which can slightly impact your score. On top of that, rapidly moving debt around without paying it down can create a pattern that suggests financial instability to lenders. To avoid this, use balance transfers strategically and focus on paying down the transferred balance quickly.
13. Maxing Out Store Credit Cards
Store credit cards are convenient for making purchases, but they often come with higher interest rates. Maxing out these cards can quickly lead to high credit card balances and, consequently, a higher credit utilization rate. To mitigate this, use store credit cards responsibly and pay off the balances promptly to avoid impacting your credit score.
14. Collections and Charge-Offs
When a creditor writes off your debt as uncollectible, it can become a charge-off, and the account may be sold to a collections agency. Both charge-offs and collections can have a big impact on your credit score. Even if you later pay off the debt, the derogatory mark remains on your credit report for several years. It's crucial to address collections and charge-offs promptly and negotiate with the collections agency to reach a settlement or payment plan.
15. Not Addressing Past Financial Mistakes
If you've had financial troubles in the past, like late payments or accounts going into collections, it's essential to address them and work on making amends. Some negative items, like late payments, may stay on your credit report for years, but you can focus on incorporating healthy financial habits into your life over time by consistently making on-time payments and demonstrating responsible financial behavior.
Consider These Important Factors
Your credit score is a valuable financial tool that can open doors to opportunities or close them off, depending on how you manage it. It's important to be aware of the factors that can impact your credit score and take steps to address and prevent them.
By paying bills on time, keeping credit card balances low, and monitoring your credit report for errors, you can work to maintain a healthy credit profile. If you're facing challenges, consider seeking advice from a financial advisor to help you navigate the path to credit score improvement. Remember, a strong credit score can positively impact your financial well-being and future opportunities.