by Jeff Hindenach of NextAdvisor.com
You have credit cards. You pay all your bills on time. You never go over your credit limit. You seemingly follow all the rules of responsible credit usage and yet you’re having trouble moving your credit score into that illustrious “excellent” category. What are you doing wrong?
Damaging your credit score is easier than you might think, particularly with all the misconceptions about credit floating around. The main problem is many of us don't know how our credit score is calculated and therefore have no idea what we’re doing wrong. Paying your bills on time is only a fraction of what makes up your credit score.
Before we can raise our credit score, we must first be aware of the following 5 things that can hurt our credit.
1. We avoid credit. Many people think that credit cards equal debt. Debt is bad, so credit cards must be bad too, right? Wrong. Having little or no credit can be detrimental to your credit score. The whole point of a credit score is to show that you know how to handle credit. If you don’t have credit history, lenders have no way of knowing if you can deal with debt. Debt is bad, but credit cards are not when used responsibly. Limiting your credit card spending to a small percentage of your credit limit and paying your cards off each month will help keep your credit score strong.
2. We close out credit cards or lower our credit limit. If you think lowering your credit limit or canceling that extra credit card is a good idea, think twice. While these actions may help ease the temptation to spend, they can also hurt your credit score. Here's how: One of the main factors of your credit score is your "credit utilization ratio," which measures your limit-to-balance ratio on your credit cards. As the ratio goes up, your credit score is likely to be negatively affected. Say your total credit limit is $5,000 and your total balance is $500. Your credit utilization ratio would be 10 percent. If you cut your credit limit to $2,500, but your balance remains $500, your ratio is now 20 percent. A higher credit utilization ratio is considered a negative factor because it means that you are using more of your credit limit.
3. We only have one type of credit. You have credit cards, and you pay your bills on time, so your credit must be pretty close to perfect, right? Not exactly. Avoiding different kinds of credit can also hurt your credit score. If you have a credit card without loans or mortgages, your score could be lower. Similarly, having only school loans without credit cards can hurt your score, too. The best way to ensure you’re maximizing your credit score is to keep a diverse amount of credit in your credit portfolio in addition to paying all of your bills on time. Of course we’d never advocate getting a loan just to improve your credit score, but it’s good to keep in mind that adding a mortgage or car loan can actually help your credit score.
4. We listen to myths about “good” debt. One of the worst misconceptions about credit is the myth that holding on to a little bit of debt can actually help your credit score. The problem is the total amount of debt that you owe, along with your credit utilization ratio, is a big factor in calculating your credit score. Holding on to debt can not only hurt your credit score, but incur additional charges that you don't need to pay. Bottom line, the less money you owe, the better.
5. We don’t check on our credit until we want something from it. Say it’s been a couple years since you checked your credit score. After all, it was fine where you left it, right? Later you go to buy a car or apply for a mortgage and discover you’ve been denied because of your credit score. It’s only then that you check your credit score and learn that someone stole your identity years ago, opening credit cards in your name and destroying your credit. Now you can’t buy that car or house and figure out how to repair all the damage.
Remember, things outside of your control can affect your credit score. Lenders can make mistakes. Your identity could be stolen with credit opened in your name. If you’re not regularly monitoring your credit score, these mishaps can drag down your score unbeknownst to you. It's a good idea to check your scores at least once a year or a few months before you think you might apply for a loan or line of credit. Consider a credit monitoring service if you want to regularly keep tabs on your credit.
While all of this advice can help you raise your credit score, the most important piece of the puzzle is paying everything on time. Timely payments show that you know how to handle your credit without taking on too much debt. Lastly, always remember the golden rule of obtaining a high credit score: less debt, more credit.
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Jeff Hindenach started his career as a journalist for the San Jose Mercury News and the San Francisco Examiner. He is currently the Director of Content for NextAdvisor.com, a leading consumer and small business information web site. He specializes in credit monitoring, legal services and security software.