Maintaining a good FICO credit score is important for expanding lines of credit, getting new loans, and even renting an apartment. There are several commonly known ways you can damage your credit score, such as being late on payments, maxing out credit cards, and defaulting. However, many lesser-known menaces can harm your credit score and negatively impact your access to money.
Some of these hidden menaces will only briefly dent your credit score while others have a major, long term impact. The following is a list of these pitfalls to avoid, roughly from least to most severe.
1. Carrying a Zero or Negative Balance
When you pay off your credit card balance to zero, or to a negative balance if, for example, you subsequently receive a refund in the same statement period, expect to see your credit score take a small, brief dip. To maintain a consistently high credit score, it is recommended you keep at least a small positive balance month after month, ideally less than 10 percent of your credit limit, although less than 30 percent is still good.
2. Too Many Hard Inquiries
Every time you apply for new credit, it results in a "hard inquiry." One hard inquiry will modestly ding your credit score for a time, but multiple hard inquiries can add up and give lenders a negative impression of your credit-worthiness. It's best to apply for new credit only when needed and perhaps limit applications for more frivolous credit accounts such as store credit cards.
Note: loan refinancing and debt consolidation will also trigger hard inquiries.
3. Paying Down Your Balance Too Late
You may think you can run up a big balance on your credit card and then pay it off on the payment due date. However, this date is not necessarily when your balance is reported to the credit bureaus. It's possible your balance was reported several days earlier, thereby recording a much higher credit utilization ratio than you intended.
Credit utilization is just another way of saying your balance as a total percentage of your credit limit. It's best to keep this consistently below 30 percent, so when your balance is reported to the credit bureaus, your credit score won't take an unexpected hit.
4. Closing Unused Credit Card Accounts
Closing a credit card you rarely or no longer use will decrease the amount of credit you have available and increase your credit utilization. Simply put, you have less headroom. Also, if it was your first credit card, canceling it will shorten your credit history and negatively affect your credit score. A longer history means a higher rating.
5. Having Only Credit Cards or Only Loans
Accounting for 10 percent of your credit score is your credit mix. If you have only credit cards and no loans, or vice versa, you will not have as high a credit score as when you have a mix of credit cards and loans, such as an auto loan or a mortgage.
6. Being an Authorized User
When you're signed up as an authorized user on someone else's credit card, their credit score can affect yours even though you're not an account holder on that card. If their credit score is high, it will positively impact yours, but if it's low, you'll pay the price for it on your own score.
7. When You're Late on Rent
If you pay rent by check or debit, you may think it has no bearing on your credit score, but if you're late, you can suffer a sizable hit. This is because landlords report rent delinquencies to the credit bureaus and it counts as a missed payment, a major no-no. If you think you're going to be late on rent, try to explain your situation to your landlord and convince him to hold off on reporting it.
8. Failure to Pay Taxes
If you're hit with an IRS lien for failing to pay taxes, credit bureaus detect this and count it as a delinquency which will have a major negative impact on your score. The record of the delinquency also won't go away anytime soon. It will remain on your record for seven years or more.
9. Being Underwater on Your Home
When you're underwater on your mortgage, it's pretty obvious your credit score will suffer if you have to foreclose. Less obvious are the effects of a short sale where the mortgage provider accepts a sale price less than what is owed by the mortgage in order to settle the debt. This can cause a big dip in your credit score.
Similarly, a deed in lieu of foreclosure, where you sign over your home's deed to the mortgage provider, will severely lower your credit score.
10. Inaccurate Credit Reports
Your credit report is not the same as your FICO credit score. Your FICO score is just a number derived from several factors, including payment history, credit utilization, and credit mix. Your credit report, on the other hand, is the detailed history of all your credit accounts and loans that determines your credit score. The problem occurs when there is a mistake in your credit report (the people compiling these reports aren't perfect) and when that mistake results in a lower credit score.
Since you can get a free credit report annually from each of the three credit bureaus (Equifax, Experian, and TransUnion), you should periodically review your reports and ensure their accuracy. If you find a mistake, you can dispute it with the credit bureau.
Managing your credit score can be easy or hard depending on your financial health, but avoiding mistakes is always easy with a little knowledge. Knowing all the hidden menaces to your FICO credit score in advance will help you make smart decisions which could make the difference in getting a good mortgage or achieving your other financial goals. Your FICO credit score is a big part of your future, so don't neglect it.