How To Avoid the Credit Wreckers

Introduction

Credit is typically something you need to learn about through experience, since it’s not often taught in school. But people with good credit have cracked that code, so they tend to follow similar habits and best practices. And they know what common credit-wrecking actions to avoid.

How Does Credit Work?

Millions of consumers get credit from thousands of lenders and creditors, like banks, credit unions, auto finance firms, and mortgage brokers. Those lenders then report account activity to the three major credit bureaus — Experian, Equifax, and TransUnion.

Each credit bureau takes the data reported about you and compiles it into a credit report. But not all creditors report to all three bureaus, so your credit reports may be different from one bureau to the next.

Finally, two major credit scoring companies — FICO and VantageScore — calculate your credit scores from the data in those reports. Since they each have several scoring models with slightly different calculation criteria, your credit score can change depending on where you get it from and which version they use.

What’s a Credit Wrecker?

Credit One Bank launched “The Credit Wreckers” as a character-driven initiative that focuses on common credit missteps. Each character personifies one of these missteps in a playful, easy-to-understand and informative way, which helps encourage improved credit habits.

The Credit Wreckers help shine a light on credit-related topics like payment history, credit utilization ratio, length of credit history, credit mix, and the importance of paying attention to your credit profile.

Why Paying on Time, Every Time is Crucial

Miss Payment means well, but more often than not, she misses her monthly payments — which can impact her score.

Payment history is the most important factor in credit score calculation for nearly every credit scoring model. That means making at least the minimum payment every month is one of the best things you can do for your credit score. And paying late, or completely missing payments, is one of the worst.

In fact, every missed payment can stay on your credit report for up to seven years. And “missed” in the credit card industry typically means more than 30 days past due. That’s the point where a complete billing cycle has passed without payment, and that’s when most creditors will report the missing payment to the credit bureaus.

Forgetting to pay your credit card bill might seem like a small thing, but it can take a big toll on your credit. And it can easily happen if you’re not paying attention.

Since paying on or before your due date is the best way to prevent late or missed payments, it might help to bring in the reinforcements. You can outsource the “remembering” part to technology, whether that’s creating calendar notifications, setting up alerts in your credit card app, or using AutoPay. Most cards let you pay the minimum due or full balance automatically, and you can usually even customize your due date so the money’s coming out of your bank account when it makes sense for your financial situation.

How Much of Your Credit Line To Use

Max Out’s eyes are bigger than his wallet. When he sees something he wants, he buys it… and his credit score pays the price.

When you’re new to building credit, it’s natural to assume that you can use your credit line as needed. So with a $1,000 credit limit, you should be able to charge up to $1,000, right? Well, in theory, that might be true. But in practice, it’s not a good idea.

Most people are shocked by the number when they first hear this. But experts recommend only using 30% or less of your credit limits. So if you have a credit card with a $1,000 credit limit, that means not charging more than $300 to it.

That percentage is known as your credit utilization ratio, and it measures how much of your credit lines you’re currently using. Credit utilization is the second-most important factor in calculating your credit score.

You can typically set a notification in your credit card app to alert you if you reach a specific balance amount. That helps you keep an eye on your utilization and stop spending when you get the message.

Creating a budget is another activity that can help you keep your credit utilization under control. A lot of people avoid sitting down and making a budget, but it’s usually well worth the effort.

You’ll need to put in some initial work to figure out your income and expenses, or what’s coming in and what’s going out. Then you can balance your wants against your needs. Most of your expenses should be going to needs, like food, housing, and transportation. But if you have room left, you can assign a discretionary budget to your wants — things like entertainment, dining out, small rewards, or personal travel.

Some common budgeting systems include zero-based budgeting, envelope system budgeting, and 50/30/20 or 70/20/10 budgeting. You only need one, so you can just pick the system that works best for your specific needs.

How a Diverse Credit Mix Can Help Your Credit Score

One Track Jack only has eyes for one... one type of credit, that is, which results in a thin credit file.

Credit mix isn’t something people typically talk about, unless it’s directly related to a conversation about credit scores. Because that’s when it really matters.

Your credit mix refers to the types of credit you have, like revolving credit, installment credit, and open credit. Revolving credit includes credit cards and lines of credit that you can reuse after paying them down. Installment credit includes loans and mortgages that are paid through fixed payments and are typically closed after you pay them off. Open credit includes certain charge cards and other accounts that generally require the balance to be paid off in full each month.

For credit scoring purposes, revolving and installment accounts are the most common types of credit considered in your credit mix.

Lenders like to see that you can manage different types of credit well, so having a diverse credit mix can help improve your credit score. However, applying for new accounts just to mix it up can backfire, because each application is a hard inquiry that could negatively impact your score. And you don’t want to become buried under too many accounts, which could cause you to fall behind.

Why Keeping Older Accounts Might Be a Good Idea

Cancelina loves to cancel her credit cards after they’re paid off, which can affect the length of her credit history and other factors.

If you have an older credit card that you don’t really use anymore, you might be tempted to close the account. But several things point to the benefits of keeping that card open.

First of all, most credit scoring models look at the ages of both your oldest and newest accounts. But they deal with the calculations slightly differently.

FICO doesn’t give quite as much weight to whether your oldest credit accounts are still open or not. They include closed accounts in your length of credit history for up to 10 years.

So even if you cancel a credit card, it will still typically show up on your credit reports until that 10-year mark. But if that account was older than 10 years, it effectively becomes non-existent after it’s closed. And that matters because FICO reports that the average person with a perfect 850 credit score has a credit account that’s been open for 30 years, not just 10.

VantageScore takes a slightly different approach, and some of their models calculate your length of credit history based only on your currently open accounts. So in VantageScore’s world, canceling an older card can reduce that time frame and potentially lower your credit score, regardless of how long you’ve had the card.

Average age of accounts is another calculation, and that one always relies on open accounts. So if you have three credit cards, and one has been open for 14 years while the other two are only two years old, your average age is six years. But if you close the oldest card, your average age is only two years. Dropping the average age that much will usually drop your score along with it.

Then we have other factors at play, like your aggregate credit utilization ratio. Instead of focusing on one card, this calculation considers your overall utilization across all your revolving accounts. And if you close one card with a $1,000 credit line, that reduces the available credit by $1,000 — which can bump up your utilization rate.

Let’s say you had three credit cards with limits of $2,500, $1,500, and $1,000 for a total of $5,000 in available credit. The first two have outstanding balances of $1,000 each, so your aggregate utilization is 40% ($2,000 used out of $5,000). By canceling that $1,000 credit line, you’re suddenly at 50% utilization ($2,000 used out of $4,000).

Canceling that card can also reduce the diversity of your credit mix if you only had one or two revolving credit accounts but currently manage several loans.

Why Monitoring Your Credit Can Make a Big Difference

Everything we’ve talked about is under your control, but it’s hard to see the impact of each behavior without taking a look at the big picture. And your credit report is like a map showing you where these actions are taking you.

The credit bureaus each gather reported data from lenders and creditors across the country. Since lenders can choose who to report to, not every bureau gets the same data. So your credit reports are likely different from each bureau.

Checking your reports on a regular basis lets you see a lot of important information in your credit profile, including the current status of your accounts. That shows you a list of your creditors, the account balances, and your payment history. On-time payments will be noted, as well as missed payments going back seven years.

But that list of informative data is pretty useless if it’s not correct. So you’ll also get to see if your credit report is accurate, or if it contains any common errors. That can include personal details, like your name and address, or credit-related activity, like incorrectly reported payment history. It may also include fraudulent accounts that an identity thief opened in your name. If you do find mistakes, or signs of fraud, you can dispute them and have them corrected with the corresponding credit bureaus.

By law, you have the right to get a free copy of each of your credit reports once a year. But you can now get them every week at AnnualCreditReport.com.

Your credit score is also important to monitor because it provides a snapshot of your credit profile as a three-digit number that creditors use to make decisions. Credit reports don’t usually include your credit score, but you have other ways to check that too. Banks and credit cards will sometimes offer a free monthly credit score to customers, or you can get them from a third-party service. Several websites specifically provide credit scores, monitoring, card ratings, and financial education.

Bottom Line

Having good credit opens a lot of doors to opportunities, including better terms on loans and car insurance, access to housing, and even better employment opportunities. And certain strategies, activities and habits can help you raise your credit score.

On the flip side, it’s possible to wreck your credit without even realizing it. And it happens to unsuspecting consumers every day. But now that you’re familiar with credit-wrecking behaviors, it’s much easier to avoid the Credit Wreckers.