There is a magic number that can mean thousands of extra dollars in your pocket. It tells strangers something about you, but it’s not your income, your monthly spending, or your date of birth. It’s your credit score. It tells credit card companies, car dealers and bankers whether or not to loan you money and what interest rate to charge you if they do. Even landlords can access this number to determine whether to rent a property and how much to charge. A good credit score can save you thousands in interest charges over the life of a loan, while a poor credit score can mean a loan or credit card application being turned down. Get yours free online thanks to the Fair and Accurate Credit Transactions Act of 2003 and avoid some of these common mistakes that hurt your credit score.
Your payment history is the largest component of your credit score, greater even than your total amount of debt. Consistently paying bills on time will keep your credit score high, including car payments, home mortgage, utility bills, credit card debt and even medical bills. Credit card companies typically charge-off accounts that are six months delinquent; that is, the charged-off status remains on your credit score for seven years, you can no longer make purchases with the account and you still owe the balance. Defaulting on a loan or having overdue accounts sent to a third-party collection agency similarly wreaks havoc on your credit score. Bankruptcy is the train wreck of credit; it can devastate your credit score and make it very difficult for you to take out any new loans or open new lines of credit for several years, remaining on record for a full decade.
Your level of credit includes not only how much you owe but the ratio of credit used to available credit, called credit utilization ratio. A ratio lower than thirty percent is good for your credit score, and there are several ways to keep it low. It’s clear that keeping low balances on all your accounts is advisable. A less common-sense approach is to keep credit accounts open, even those you rarely use, since closing them means that you have less credit available and your credit utilization ratio increases. If you do close an account, be certain that the balance is paid in full. If you close a card with a balance on it, your limit drops to $0, so you’re technically over your credit limit and as a result your score drops. Use retail cards carefully, as they often carry low credit limits, so even a small balance can mean a high utilization ratio.
Applying for Many Credit Cards and Loans
Credit inquiries, such as those made when you apply for a loan or credit card, will cause your score to dip temporarily. Don’t send out too many applications at once, and don’t be sucked in by appealing promotions to apply for just any credit card.
Using Just One Type of Debt
Ten percent of your score is derived from your credit mix, or the types of debt that you have or have used in the past. It’s a small part for most consumers but especially affects those with a shorter credit history. Lenders want to see that you can handle different types of loans, but it’s a fine line between carrying a mix of credit while keeping your overall debt low. Again, this is the least weighted part of a credit score, so it usually means the difference between good and perfect scores, not good and poor.
Not Checking for Errors
It is speculated that as many as 70 percent of consumer credit reports contain errors. Common errors include incorrect reports of nonpayment on a debt, reporting activity of someone else with the same name and accounts opened without your knowledge as a result of identity theft. Legally, you and the credit reporting agency are jointly responsible for the accuracy of the information, and it’s in your best interest to make sure it’s accurate. When you find a mistake, notify the credit bureau in writing and include copies of documents supporting your claim. The company must investigate the claim, give you the results in writing and provide a copy of your credit report if the dispute resulted in a change.
Identity theft is the most dangerous error to find because it won’t be the last if you don’t take immediate action. Fortunately, you can purchase credit monitoring to alert you to early fraud activity. And if you do get targeted, immediately notify all three consumer credit bureaus (Equifax, Experian and TransUnion) and ask them to put a fraud alert on your account, which requires creditors to contact you and verify your identity before opening any new accounts. Close any accounts that were fraudulently opened and follow up with those lenders in writing. File a police report and a complaint with the Federal Trade Commission; this online form makes it easy. For more detailed information, see the FTC’s online resources.
A credit score calculation may seem complicated, but common-sense money management will take you a long way towards a good credit history; carrying low balances, making payments on time and getting your free credit report yearly. Once your score rises above 700, a “prime” score eligible for the best interest rates, feel free to jump up and down and scream “I won! I won!” because, in the long term, you did.