4 Ways You Might Be Doing Damage Without Knowing It
Even if you always pay your bills on time, you may be hurting your credit score without realizing it. Yes, paying on time is key, but credit scoring formulas take into account more than that.
#1: Applying for New Credit: Learn to Say "No"
Thirty-year-old Erin Bedillion (right) says if she hadn’t gotten in trouble with credit, her life would be different and she could stay at home with her daughter, Caisen (left).
Do you feel like every time you buy something, the clerk offers you a credit card? Erin Bedillion did and says she had a hard time saying “no.” The 30-year-old Gibsonia, Penn., mother of two admits she was a sucker for discounts and over time, she ended up with six new cards.
You might think signing up for a card is no big deal, and that it's even a smart idea because of all the deals you’ll score. But all those store cards can have a negative effect on your credit score.
“Each time you apply for credit, a credit inquiry shows up on your report and pulls down your score a little,” says Will VanderToolen, director of counseling services at the AAA Fair Credit Foundation in Salt Lake City. “This is true regardless of whether you have new or established accounts.”
That’s exactly what happened to Bedillion’s credit score, but she's since learned to ignore the temptation.
Bottom Line: Weigh the benefits before signing up for a new card.
Don’t apply for credit that you don’t need. – Will VanderToolen
“Don’t apply for credit that you don’t need,” says VanderToolen. “But also don’t avoid getting a card at a store you frequent if the benefits will yield positive over time."
#2: Never Using Credit: You Need a Credit History
Choosing whether to use credit can be a Catch-22. You might not want to use credit because you’re:
- Nervous about managing it
- Worried about damaging your credit score
- Wanting to avoid building debt
- Concerned with all of the above
But someday, you’ll need a loan—to go to college or to buy a house or a car—and if you don't have a track record of responsible credit use (i.e., a credit history), you'll have a harder time getting the financial backing you need. Plus, credit scores are used by more than lenders.
Some borrowers mistakenly believe that they can build credit history by managing their bank accounts and debit cards wisely. While that’s important to your overall financial well-being, it will not help you build credit.
"Even if you run your debit card as a credit, it will not report to your credit file," says VanderToolen.
Bottom Line: Consider how you can comfortably and responsibly build credit early on, so you have it when you need it.
#3: Canceling a Card You Don't Use: Erasing the Past
Canceling cards you don't use can be a good way to avoid the temptation to spend, but it can hurt your credit score in a couple ways:
- First, it shortens your credit history, which is what lenders look to for background on how responsible you are with your finances (and therefore, the likelihood that you’ll pay them back if they lend you money). This is especially true if it is a long-held account—losing that lowers the average length of your account history.
- Second, removing a line of credit can lower your credit utilization ratio. This ratio is a measure of how much of your available credit you're using.
For example, if you have four cards with $10,000 of available credit, and you have $2,500 of balances, you're using 25 percent of your credit, which VanderToolen says is a safe ratio. But if you cancel two of the cards, lowering your available credit to $5,000, you're using more of your available credit—50 percent—which can negatively impact your score.
Bottom Line: Consider the overall impact of canceling a card before pulling the plug. If you’re worried you’ll use the card if you keep it open, cut up or hide the card while leaving the account open.
#4: Maxing Out Credit Cards: Making Yourself Look Needy
Credit limits are like a trick question. Lenders give you a certain amount, but that doesn’t mean they want you to spend it all—it’s a test to see how restrained you can be. As you approach your spending limits, you’ll increase your credit utilization ratio, which lowers your score and can lead lenders to think you have a difficult time managing the money you’ve borrowed.
Furthermore, if you max out your card, you’ll probably be less likely to pay off the balance—which can hurt your score and your future self.
There was a time when Bedillion's cards were almost all maxed out. Even when she had long periods of discipline on a tight budget, she had relapses.
“I'd say, ‘I’m sick of wearing the same clothes, I'm sick of wearing the same shoes, and not having enough food,' so I’d go out and charge $500," she says. "That's money that already took a long time to pay off."
Bottom Line: Take a cue from Bedillion, who says even if you slip, don't wallow in it and find a way to get back on track.
My life could be completely different if I had done things differently. I could be a stay-at-home mom and enjoy my daughter and not worry every day about money. – Erin Bedillion
"My life would be completely different if I had done things differently," she says. "I could be a stay-at-home mom and enjoy my daughter and not worry every day about money."
[Any reference to a specific company, commercial product, process or service does not constitute or imply an endorsement or recommendation by the National Endowment for Financial Education.]