Most people know the importance of making at least minimum credit card payments on time, and avoiding financial no-nos like bankruptcy and foreclosure if possible. However, some less obvious factors can still make a negative impact on your credit rating. They may seem counterintuitive, and some may go against what you’ve been told in the past, but Tim Chen, CEO of the credit-card search website NerdWallet, will explain why these five practices can wreck your credit score.
1. Settling past-due debts with a creditor to pay less than you owe. Anyone who has amassed enough credit card debt has gotten the pitches in the mail, and sleepless fretting debtors see the ads on late-night TV: Pay Down Your Debt! It sounds too good to be true, and Chen confirms this. “Even though you're getting rid of bad debt, it stays on your report as 'settled' rather than 'paid off,' and is now updated on the payment date, making it look like it happened more recently than the original loan. Your credit score is weighted more heavily toward recent events than past events, so taking a bad debt from the past and moving it to the present will count against you.”
2. Transferring balances from a high-interest account to a low-interest account. Ahh, the old trick of debt-juggling from card to card. You get an offer for a new card with an enticing 0 percent annual percentage rate for a whole year. Who knows what might happen in that interest-free year—you could even pay off this debt for good, right? Balance transfers can seem like a good idea at the time, but Chen says, “While it's better for your bottom line, opening new accounts works against your credit score. Plus moving all your debts to one card could negatively impact your credit utilization (your ratio of debt to available credit).”
3. Closing old credit cards. One school of thought holds that the more credit you have open, the more risk that it could be misused, or it could leave you more vulnerable to fraud, so you should close your unused cards. But closing cards hurts you two ways, says Chen, by increasing your debt utilization and shortening your credit history length. “Creditors like to see that you have a lot of unused, available credit, and that you have accounts that have been open for a long time without problems.”
4. Paying off your car or your mortgage. What? Paying off your mortgage can work against you? Chen steps in to explain the enigmatic concept of “credit mix.” “FICO reports that 10 percent of your credit score is determined by your ‘credit mix,’ and they like to see a variety of installment and revolving loans. If all you have is an auto loan and three credit cards, paying off the car will leave you with nothing but revolving credit.” However, Chen points out that in that case you might want to focus on paying off that debt.
5. Avoiding debt altogether won't help you. So basically, no matter what, you’re doomed! (Kidding. See the conclusion below for a glimmer of hope.) “While eschewing debt is in vogue these days, your credit score is based on how well you can handle credit, and all of your score's components are based on you having open debt accounts,” Chen says. That means that even if you are anti-credit cards, well-managed credit accounts will eventually help your case if you plan on getting a mortgage.
It may now seem like credit scores are a hopeless “damned if you do and damned if you don’t” situation. But there are ideals you can strive for to achieve a good credit rating. Chen points to Lending Club’s rate table, which has remarkably transparent disclosures, for some parameters to aim for.
Based on their data, you can draw the following conclusions:
- The ideal number of loans or credit lines open is 6-21. Therefore, it's pretty difficult to get penalized for having too many accounts.
- The ideal number of credit inquiries is 0-3 in the last 6 months. Anyone who has had 6 or more will have a tough time getting a loan. This can be troublesome when shopping around for mortgage rates. "Soft pulls" of credit scores (such as when you check your own credit score, or when a potential employer does) are always better, when possible.
- A 5+ year credit history is ideal.
- 5% to 85% credit line utilization is ideal.
And don’t forget the basics: pay off at least the monthly minimum balance for many years running.