The Top 10 Credit Mistakes
By John Ulzheimer for Credit.com
1. Closing Credit Cards Accounts
Some of you may wonder why Closing Credit Cards is number one on this list as the biggest credit mistake even above Missing Payments. In fact, closing credit cards is almost as bad of an idea to increase your credit scores as missing payments, but it is also a clear number one on the list of credit myths. It is perhaps the most common piece of advice that consumers are given when they ask,” How can I increase my credit scores?”. If there were ever a wolf in sheep’s closing as far as credit mistakes go, it’s this one. Closing credit card accounts will not increase your credit scores. So called “industry experts” such as mortgage lenders suggest that you close credit cards as a strategy to increase your credit scores to qualify for home loans. However, there are two huge reasons not to close credit cards that you no longer use. They are:
2. Missing Payments
The reason missing payments is number two on the list instead of number one is that it doesn’t take a credit scoring expert to tell you that missing payments is a bad thing. It’s common sense, unlike Closing Credit Card Accounts. The explanation why missing payments is a huge mistake is also fairly obvious. Credit scores look at your credit history to see how you have managed your current and past credit obligations in an effort to predict how likely you are to miss payments in the future. The most powerful “predictor” of future late payments is having missed payments in your past. There are three ways that missing payments will hurt your credit scores. They are:
3. Settling With Your Lender on a Past due Account
“Settling” is a term used in the consumer credit industry that means accepting less than the amount you owe on an account. For example, if you owe a credit card company $10,000 but you can’t pay them the full amount then they will likely make you a deal for less than that full amount. They have “settled” for less than the full amount, which is likely much less than you contractually owe them. This may seem like a good idea because you are happy that you didn’t have to pay the full amount. However, the lender will report that remaining amount to the credit bureaus as a negative item. This remaining amount is called the “deficiency balance”. A deficiency balance is considered just as negatively by credit scoring models as any other severe late payments. If you can arrange a deal with your lender so that they will NOT report the deficiency balance then that will be your best course of action. If they will not agree to this then you have to figure out a way to pay them in full or your credit will suffer for 7 years.
4. Over Utilization of Your Available Credit Card Limits
Having high balances on your credit cards will undoubtedly cause your credit scores to go down, and in most cases, in a big way. The mistake you are making is called “over utilization.” Over utilization is the practice of running up balances too close to your credit card limits. For example, if you have a Visa card with a credit limit of $10,000 and a $5,000 balance you have a utilization percentage of 50% because you are using 50% of your credit limit. The higher that percentage the fewer points you will earn for your credit scores. If your balance is $9,500 then you will be 95% utilized and in big trouble. Your best bet would be to use your cards sparingly and pay them down as much as possible each month. If paying your cards off every month is unrealistic then try your best to keep that percentage as low as possible. There is no magic target to shoot at, but it’s safe to say that the lower the percentage the better.
5. Excessively Shopping for Credit
Every time you fill out a credit application you are giving the lender permission to access your credit reports. When they access your credit reports they automatically post what is called an “inquiry”. The inquiry is a record of who pulled your credit report and on what date. Federal law requires that the lender post the inquiry. It also requires that the inquiry remain on the report for 24 months.
Inquiries are used by credit scoring models to determine whether or not someone is shopping for credit. It is a statistical fact that consumers who have more inquiries are higher credit risks than consumers with fewer inquiries. As such, the more inquiries you have the more points you will lose in your credit scores. While the exact point value is a closely guarded secret by the credit scoring companies you should assume that your scores would suffer if you have an excessive amount of inquiries.
Probably the most troublesome byproduct of holiday shopping is the collection of inquiries that consumers end up with. Think about this scene: you go to the mall to go shopping and are enticed by offers of “10% off today’s purchase” in exchange for applying for a store credit card. This sounds like a great idea because you are saving a few bucks on your purchases. But if you look at the big picture you will see that this is a horrible idea with dire consequences. If those excessive inquiries cost your credit score 10, 20 or 30 points you could expect to pay higher interest rates on either a future home or car loan. Either way, the thousands of additional dollars that you will spend in interest far outweigh the $20 you saved at the mall.
Think twice about applying for a store card simply to save a few dollars. It’s a better idea to pay for the product with cash, a check or a credit card you already have.
6. Thinking that all Credit Scores are the Same
Credit Scoring is already a confusing enough topic to understand. Add to the mix that there are as many different types of credit scores as there are soft drinks and it gets really confusing. The most commonly used credit score is a credit risk score. A credit risk score is designed to assist lenders by predicting whether or not a consumer will pay their bills on time in the future. The most common credit risk score is designed and developed by a company called Fair Isaac Corporation. This Minneapolis based company builds the industry standard “FICO” score. FICO is an acronym for Fair Isaac Corporation. The vast majority of lenders use their scoring models as part of their standard lending procedures.
There are many different places where consumers can purchase their credit reports and credit scores however not all of the scores being sold are, in fact, the authentic FICO score. On the surface this might not seem like a big deal but it certainly can be. For example, if you are in the market for a new car and you purchase a credit score from a web site that no lender uses then you are really no better prepared to go car shopping. If, however, you purchase the authentic FICO scores then you will have the same exact score that the car dealers will eventually see when they run your application for credit. This can be incredibly empowering for the shopper because you’ll know what your credit situation is before the dealer does. Given that there is a general distrust of car dealerships this will ensure a fair negotiation process when it comes to dealer financing. It will be more difficult to be taken advantage of by an unscrupulous dealership.
When you are shopping online for your credit reports and credit scores be sure that the score you are buying is branded as the authentic FICO® Credit Score. These can be purchased through various reputable web sites such as www.myfico.com and www.equifax.com.
7. Thinking that all Credit Scores Predict the Same Thing
Adding to the confusion in number six above is the fact that there are models that predict other things than general credit risk. Scoring models can be built to predict almost anything including:
8. Not Understanding Your Rights Under The Fair Credit Reporting Act
This act, commonly referred to as the “FCRA”, is a list of the rules and regulations that govern lenders and the credit reporting agencies. You should become familiar with your rights under this act which can be accessed at no cost at the Federal Trade Commissions web site. The address is www.ftc.gov. Some highlights are:
9. Not Knowing that you Have Three Credit Reports and Three Credit Scores
Most consumers understand that they have a credit report. However, most consumers do not know that they have three credit reports compiled and maintained by three separate and competing companies called “Credit Reporting Agencies.” These companies are essentially warehouses that store your credit history and sell it to lenders who want to grant you credit. These companies are:
Each of these companies maintains credit files on over 250,000,000 consumers, which they sell to lenders. They do not share credit information with each other since they are competitors. As such, you will likely have a unique credit report and credit score at each of these companies. Do not assume that your credit reports and scores are all the same.
10. Not Having Credit (or a Credit Score)
That’s right. Not using credit is a huge mistake. The way the credit system in this country works is that it rewards consumers who manage credit responsibly. The reward is in the form of easy access to inexpensive loans. However, choosing to not use credit will prevent you from building a solid credit history and score and will subsequently make it very difficult to secure home or auto loans when the time comes.
Secondly, not having a credit history will result in you not having a credit score. Credit scoring models depend on your previous credit history from which to generate a score. Not having a credit score will make it more difficult to apply for and obtain credit because most lenders use automated systems in order to process your applications. A lack of a credit score will make it more difficult for lenders to process your applications. Some will simply chose to decline your applications rather than manually process them.
Top 10 Credit Mistakes
February 15, 2013