A bad credit score can cost you tens of thousands of dollars, so learn what not to do so that your score doesn't get whacked. Better still, learn how to boost your score and save even more.
You probably know that a robust credit score will open financial doors for you and save you a lot of money, such as by qualifying you for the lowest interest rates when you borrow money for a mortgage or a car loan.
You may not appreciate just how easily you can kill your credit score, though, by making a mistake or two. For example, mistakes that can hurt your score include late payments, a newly closed account, and an ill-timed inquiry from a lender. Being informed can keep your debts under control.
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An intro to credit scores
Before learning how you might hurt your credit score, be sure to understand just what it is in the first place. As you go through your financial life -- paying bills or not paying them, and doing so on time or late, records are kept and reported to the major credit agencies. Data from your credit records and histories are then used to calculate credit scores -- there are many kinds -- and these scores are used by prospective lenders to help them decide whether they want to lend to you and what kind of interest rate they want to charge you.
Credit scores fall in different ranges according to which score you're looking at. Basic (non-industry-specific) FICO scores, which are used by about 90% of top lenders, range from 300 to 850. Here's how the folks at FICO rate the scores.
FICO Score Range | Rating |
|---|---|
800 and higher | Exceptional |
740-799 | Very good |
670-739 | Good |
580-669 | Fair |
579 and lower | Poor |
Data source: MyFICO.com.
Want to see what a difference a great credit score can make in your life? Check out the following example of mortgage payments for someone borrowing $200,000 on a 30-year fixed-rate loan:
FICO Score | APR | Monthly Payment | Total Interest Paid |
|---|---|---|---|
760-850 | 3.554% | $904 | $125,486 |
700-759 | 3.776% | $929 | $134,506 |
680-699 | 3.953% | $949 | $141,791 |
660-679 | 4.167% | $974 | $150,707 |
640-659 | 4.597% | $1,025 | $168,975 |
620-639 | 5.143% | $1,091 | $192,828 |
Data source: MyFICO.com,as of Oct. 20, 2017.
Image source: Getty Images.
Mistakes that can kill your credit score
To understand some of the things that can depress your credit score (and, conversely, that can boost it), it's helpful to understand the componentsthat go into it. Here are the factors that make up a FICO credit score:
Component of Credit Score | Influence on Credit Score |
|---|---|
Payment history | 35% |
How much you owe | 30% |
Length of credit history | 15% |
New credit | 10% |
Other factors such as your credit mix | 10% |
Data source: myFICO.com.
Now, let's review the mistakes to avoid making.
Mistake 1: Late payments
Not surprisingly, a key way to depress your credit score is by paying bills late. Just about any creditor can report you to credit agencies. Landlords may report you, as might owners of a storage unit you rented and plenty of others to whom you owe money. Even a late or unpaid libraryfine can end up dinging your score, as can overdrawingon a line of credit at your bank that's meant to protect you from overdraft fees.
Mistake 2: Owing too much
Thirty percent of your score is tied to how much you owe -- a measure referred to as your credit utilization ratio. Lenders who are considering lending to you don't want you to have maxed out your credit limits or even come close. Ideally, they'd like to see you having borrowed only about 10% to 30% of the sum of all your credit limits.
If you have a lot of debt, it may not be easy to pay it off, but it's in your best interest to do so -- at least with high-interest-rate debt. Know that many people have paid off tens of thousands of dollars of debt -- some more than $100,000! -- and have gone on to live financially healthier lives. One of the most effective ways to get out of debt is to pay off your high-interest rate debt first. Those credit card rates of 20% or higher are much more costly to you than a 5% mortgage or car loan.
Mistake 3: Closing accounts
Another mistake is closing accounts, especially old ones. Remember your credit utilization ratio? It reflects how much of your available credit you've tapped. If you close credit card accounts, you'll lose those available credit limits. For example, imagine that you owe a total of $10,000 and all your various credit limits total $40,000. If so, your credit utilization ratio is 25%. If you close some accounts, though, and your total credit limit falls to $20,000, your ratio will swell to 50%, hurting your credit score.
You can't control the overall length of your credit history too much, but you can be sure to not close out old credit card accounts, as older histories are more valuable. (Opening new credit card accounts can hurt your score, as it will lower the average age of your credit accounts.)
Image source: Getty Images.
Mistake 4: Overshopping for credit
Opening a lot of new credit accounts can also hurt your credit score, at least for a while, because each time you apply for credit, a potential lender will pull your credit score, to check it. Too many such pulls can hurt your score -- though a bunch done within a several-week period might just count as one, such as if you visit a handful of lenders when shopping for a mortgage.
Mistake 5: Co-signing a loan
Co-signing a loan for a loved one can be a nice thing to do, but it can also hurt you, if that borrower makes late payments or misses some payments. It's also not ideal if it makes your credit utilization ratio too high. (On the other hand, cosigning can be helpful to your score if the loan is paid off responsibly.)
Mistake 6: Bouncing checks
Bouncing checks and otherwise being a suboptimal manager of your money can also hurt your credit score. Such actions can end up with a financial institution hiring a collection agency to go after you, which can end up on your credit report and can ding your score.
Mistake 7: Not reviewing your credit report and score regularly
Finally, a last mistake is assuming that your credit score is good. Even if you've paid bills on time and in full, there might be an error on your credit report that results in a lower-than-expected score. It's smart to check your credit report regularly -- especially before you need to borrow money. Sometimes errors result because the credit agencies weren't informed when you moved or changed your name, and bills paid on time were therefore not credited correctly to your account. You're entitled to a free copy of your credit report annually from each of the three main credit agencies -- visit AnnualCreditReport.com to order yours -- then check it for errors and fix any that you find.
If you're a responsible manager of your money, borrowing only what you can afford to repay, paying bills on time, and generally living below your means, your credit score will reflect that and lenders will reward you. A high credit score can save you many thousands of dollars over your financial life.
