Credit isn’t cut and dry. You may think you’re doing the right things by limiting credit card usage and paying the minimum payment. However, some of the things you think are right are actually hurting your credit.
That’s because your credit score is based on multiple factors: payment history (35%), credit utilization (30%), credit history (15%), credit mix (10%) and new credit (10%). So if you don’t use your credit at all or use too much, you’re going to hurt your score. If you only pay the minimum amount, that will also cause your score to drop.
Want to learn more about credit card myths? Check out these 10 Big Credit Card Myths Revealed and Debunked.
Seem confusing? You’re not alone. Read on to decipher how your credit score works and learn which habits you need to fix today so you can raise your credit score.
1. Closing an old account.
You finally paid off a huge debt on a credit card, so you think this is the perfect time to close it once and for all. Don’t make that call yet! Closing an account you’ll no longer use can actually hurt your credit score. That’s because of two of the factors listed above: credit utilization and credit history. If you’re considering closing a card you’ve have for 20 years, you’ll lose all that history you accumulated with that card. On top of that, your credit utilization could actually rise. That’s because this rate is based on all your available credit.
To demonstrate this point, let’s say you have two credit cards. The one you just paid off has a credit limit of $10,000. The other has a balance of $5,000 with a limit of $10,000. You’re currently using $5,000 of your $20,000 total limit, which is a credit utilization rate of 25%. Close off the card you paid off and you lower your available credit. In this case, your credit limit drops to $10,000. This means your credit utilization rate will double to 50%. This will significantly drop your score, so if you can, keep your accounts open.
2. Having no credit at all.
Many young people have been warned of the dangers of credit cards. Therefore, they are in the mindset that no credit is good credit, but that’s simply not true. We all need credit. Without it, buying a car or house is nearly impossible unless you have a ton of cash on hand. In addition, landlords, employers and even utility companies check credit. Without credit, you could be considered a risk and charged more for basic services. You may lose out on job opportunities. If you don’t have a credit card, you need to get one. It can be one with a low limit. Just use it for groceries or other small purchases and pay it off each month. You don’t need to carry a balance, but note that those with credit card utilization rates between 1% and 10% have the highest credit scores.
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3. Not wanting a higher credit limit.
You may think that more credit leads to irresponsibility. Therefore, if your credit card company raises your credit limit, you may be quick to reject it. That move will actually lower your credit score. Why? Because of credit card utilization. If your current credit limit is $5,000 and your balance is $1,000, then your ratio is 20%. If your credit limit rises to $10,000, your ratio will drop to 10%, which will put you in a better bracket. This will raise your score. Therefore, you should embrace - not reject - that higher credit limit.
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4. Using debt settlement.
Debt settlement involves working with a third party to settle your debt for less than what is owed. You still have to pay part of the debt so that the company can make money off of you, and the end result is that your credit score can still suffer. Debt settlement is hit or miss. If you’re behind on payments and you want to remedy the situation, the best course of action may be to contact the credit card company directly and ask about any options that are available to you.
Credit is very important to us. It’s used to determine whether or not we qualify for a loan and how much interest we pay. Without good credit, your purchasing power will be severely limited. You may not be able to buy a car, house and or other major purchase. Credit opens a world of opportunities – it just needs to be used wisely. Review the money habits above to change your credit score for the better.