By Aleksandra Todorova
EVERYONE MAKES MISTAKES, but those that hurt your credit score should be avoided at all cost.
All it takes is one little drop in your credit rating to spark a surge of lender notifications about higher interest rates, lower credit limits and denied applications. Fair Isaac's FICO score, which most lenders use, rates consumers' creditworthiness on a scale of 300 to 850 -- 850 being a perfect score. On a $300,000, 30-year fixed-rate mortgage, someone with a solid score of 700 could snag an interest rate of 5.99%, translating to a monthly payment of $1,797. Lose just one point, and you'd get a less favorable rate of 6.27% and pay $19,800 more in interest over the life of the loan.
Ironically, consumers with good credit have more to fear than those who already have a blemish or two on their record. "The higher your score, the farther it can fall," says Craig Watts, a spokesman for Fair Isaac. "[One mistake] suddenly puts you in a very different category of consumer."
To avoid falling from grace, make sure not to make any one of these five mistakes.
1. Missing a Payment
Payment history accounts for a whopping 35% of your credit score. The result: "One late payment drops your score like a rock," says Gerri Detweiler, a credit advisor for Credit.com. For a consumer with otherwise good credit, the damage could be more than 100 points. Someone with a credit score of 707 who missed payments one month could see their score drop as low as 582, according to FICO's Score Simulator.
Lenders typically only report the delinquency when your account is 30 days overdue, she says, but don't relax just yet. These days, some are reporting the missed payment after just a day or two. To help you get the check there on time, set up automatic bill pay through your bank account to avoid being late and make sure you allow ample time for everything to clear. One warning: Automatic bill pay isn't instantaneous and mistakes can happen while your money is in transit. So make sure to verify that payments have made it to their destination and have been processed. (Click here to learn more about automatic billing).
2. Maxing Out Your Cards
Spending sprees are as damaging for your credit score as they are for your wallet. The ratio of debt to available credit accounts for one-third of your score. Ideally, you want to maintain balances of around 10% of your available credit (so, $1,000 on a $10,000 credit line), and never owe more than 30%, says Curtis Arnold, founder of CardRatings.com. "Anything over that is going to adversely affect your score," he says. Maxing out your accounts could drag a score of 707 down to 637, according to the FICO's Score Simulator. In addition to spending cautiously, consumers can avoid this slip-up by asking their lender for a higher credit limit. That automatically lowers your credit utilization ratio, and can actually improve your score. An even better option: Pay your balances down before the statement cycle ends, says Arnold. That's when lenders report your outstanding balance to the credit bureaus, so a big balance -- even if paid off in full a week later -- can ding your score for the next month. "Right then it looks like you're using most of your available credit," he says.
3. Credit Lust
It can be tough to resist the lure of more credit, especially with balance-transfer offers flooding your mailbox and sales clerks touting the 15% discount for opening a store credit card. But opening new accounts can have a detrimental affect on your score. Open just one, and that score of 707 could drop to 697 temporarily, according to the FICO Score Simulator. Open two or more in a short period of time and the effect is exponential, cautions Fair Isaac's Watts.
If that's not warning enough, too many of one kind of account creates what lenders deem an unhealthy mix of credit, he says. Someone with plenty of credit cards but no mortgage or other secured or installment loans (say, auto or student loans) will have a lower score than a consumer with a mix that includes each type. In fact, 10% of your credit score is based on this factor alone.
The lesson: Don't impulsively open new lines of credit and space out your credit-card requests to minimize the hit on your score. "Only take on new credit when you really need it," says Watts.
4. Closing Old Accounts
Whatever you do, don't close out old credit-card accounts, warns Scott Bilker, founder of Debtsmart.com. "It's one of the worst things you can do," he says. Not only does it cut short your credit history, but it eliminates a portion of your available credit, bringing you right back to mistake No. 2 -- high balances compared with your credit limits.
Although you shouldn't clean house, do dust off old cards for a purchase or two. Inactive accounts aren't often calculated as part of your score. Making just one purchase, however small, every six months keeps those credit cards active. That, in turn, improves your credit utilization rate and lengthens your credit history.
5. Not Paying Attention
Just because you may not be making any of the mistakes above, doesn't mean you can sit back and let everything go. Some of the things that are most damaging to your credit score aren't obvious unless you're vigilant about reviewing your credit report. One in four reports contains a serious error, according to the U.S. Public Interest Research Groups. On the more sinister side, there might also be damage from identity theft or an old library fine unknowingly sent to collections. Get your free copy at AnnualCreditReport.com. (Found a problem? Use our resources for help on fixing errors and fighting identity theft.)
Although you'll have to pay to obtain your credit score, it's worth the $15.95 at MyFICO.com to check it on an annual basis -- or more frequently if you're preparing for a major purchase, like a home, says Credit.com's Detweiler. This year, FICO has adjusted its formula to more widely separate the good lending risks from the bad. As lenders begin using it early this summer, make sure to request your score to assess the changes. "Someone who has always thought, 'I have a good score, I don't have to worry about it,' should check again," says Detweiler.
The new formula no longer includes accounts on which you are an authorized user, which may hurt the scores of spouses, as well as young credit users piggybacking a parent's line of credit. But other consumers may actually see their scores rise, thanks to more lenient late payment and credit request weightings. In that case, you'll want the score in hand to start calling up your lenders and negotiating for more favorable interest rates, says Detweiler.
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