How NOT to Improve Your Credit

The following is a guest post from Ann-Marie Murphy of Quizzle.

When it comes to credit, I learned the hard way. And the very personal way. A few years back, I thought I’d take a shot at upping my score. I was fresh out of college, didn’t have much in way of established credit, but of course, thought I knew it all.

The best way to learn something, in my opinion, is through experience. The second best? Through someone else’s experience. Learn from my mistakes.

What NOT to Do to Improve Your Credit Score or Overall Credit Know-How:

1. Close credit card accounts that you no longer use.

I got a great offer for a credit card and immediately thought, “Now that I have this low, low interest rate and fantastic terms, I might as well close my other card since I probably won’t use it again.” Right? Wrong. First off, my other card had a solid payment history AND was my oldest credit card. By closing the account, I was effectively wiping away that long credit history. Affect on my score? Not good.

Secondly, part of your credit score is how much credit you use (total balances) compared to how much credit is available to you (total of all credit limits). The less you use and the more you have available, the better. By closing accounts, you're making the amount of credit available to you smaller, which then makes the proportion of credit used to credit available higher -- and that can take a toll on your score. And it did… on mine.

2. Take advantage of every discount that’s offered when you open a store credit card.

I know the drill. You went a tad overboard on your latest shopping trip. When you hit the register, that 10 percent off your first purchase by opening a store card offer sounds mighty enticing. And why not? It’s just one more card.

Okay, so here’s the deal: There’s nothing inherently wrong with retail store credit cards. True, their interest rates are usually pretty high and the amount of credit granted to you may be far less than your Visa or Mastercard, but they’re just credit cards. Taking advantage of the first purchase deal is okay once or twice, but don’t make a habit of it.

Opening too many store cards in a short period of time may indicate to the credit card “Gods” that you’re overextending yourself and could potentially have a negative effect on your credit score. Also, remember those high interest rates I mentioned? They could wreak havoc on your wallet unless you plan to pay off your balance in full each month. If you’re charging more than you can afford, you might be paying off that debt for a lot longer than that sweater you bought is stylish.

3. Pay down the cards with the highest balances. 

So you have a bunch of credit cards – sprinkle on top a couple student loans – and you’re wondering, where do I start? First and foremost, ALWAYS pay your credit card and loan minimum payments ON TIME, EVERY MONTH. This is the amount that you’re required to pay – usually between two and four percent of your balance. If you don’t pay your minimum payments, your interest rate will go up, you may be charged fees and your credit score will suffer.

That said, what card or loan should you pay down first? If you have a little extra cash and decide you want out of the debt game, AND you’re making sure to pay ALL of your minimum payments on time every month, put that extra dough toward the card or loan with the highest interest rate (Note: rate, not balance). When you’ve gotten that taken care of, go after the next highest rate card or loan. You’ll save money in interest, your total debt balance will decrease faster and in the long-term, your credit score will thank you.

4. Why pay it down when you can move it around?

When I started getting a ton of credit card offers in the mail, I was frequently tempted to take the balance on my credit card, which I was paying interest on, and transfer it to a new card to get the 0% interest for six months promotion (or whatever the seemingly sweet deal was at the time). The problem with transferring balances I found was that I became so concerned with how much interest I might save in those six “teaser” months that I often ignored the fine print. And by fine print, I mean the transfer fee.

Transfer fees vary, but if you don’t take the time to calculate your total real savings, you might end up paying more up-front for that transfer fee than you would have in interest if you had just stuck with your current credit card. Of course, it depends on your current rate and balance, the new credit card offer and the transfer fee, but beware! On more than one occasion, I was swept off my feet by supposedly great offers, only to kick myself with those same feet when I later realized that it actually cost me more in the long-run to transfer my balance.

Another note: while transferring balances doesn’t necessarily affect your credit score, opening a new account can. Typically, you’re okay if you’re not overextending yourself and don’t open a bunch of new accounts in a short period of time. Ultimately though, the goal is to rid yourself of debt and to pay off your entire balance in full every month. The closer you get to this goal, the higher your score should go.

 5. Ignore your credit report. It’s just a bunch of financial gobbledygook.

You never know what may lurk on your credit report. There may be mistakes that are affecting your score. Sometimes accounts that aren’t yours are erroneously added to your report. Other times, credit limits might be reported as lower than they actually are. Still other times, accounts may be listed as late when they’re current. It’s a smart move to get a copy of your credit report and go over it with a fine-tooth comb.

Some things you don’t have to worry about, as they have no affect on your score, are outdated addresses or old employment information. Things you should take a look at include:

• Each account. Is it yours? Is the balance and credit limit accurate (or close – sometimes there’s up to a 30-day lag time in reporting)? Are there any late or derogatory payments listed? If so, are they accurate?

• Closed accounts. Are these accounts supposed to be closed? If not, you may want to contact the creditor, as you could be losing out on that available credit (see tip #1).

• Hard inquiries. Hard inquiries – anytime your credit report is pulled for the purposes of extending you credit or a loan offer – can hurt your credit score. In contrast, soft inquiries – when you pull your own credit for educational purposes – will not affect your score. Take a look at your report and make sure you don’t have too many hard inquiries. If you do, did you make these credit requests? Did you recently apply for credit or a loan?

Learning how to best manage your credit takes time. And in some cases, a few mistakes. Don’t beat yourself up if you don’t always do it right. Credit scores aren’t always the most logical beasts and luckily, you can take measures to increase your score and rebound from your mistakes.

Comments

[Maria]

Credit reporting is the most underregulated business activity in the world. There is absolutely no penalty for incorrect reporting. If the average person makes an error or is victim of an incorrect entry (not to be mistaken for identity fraud )the result is devasating.
Im not surprised no one will touch this topic in the political ranks, I tried to discuss having a sit down with local politicians, and no one will give me the time of day. Lenders control the process and there is no incentive to fix this mess.
A few more points before I get off the soap box.
1. Landsafe is one of the largest credit reporting agencies. It was a business partner with Countrywide-now BofA
2. Credit scoring is not new. When introdued back in the 70/80's it was know to be flawed as a model. That didn't stop the the FICO, Fair Issac, and Beacon folks from try, try, try again. It finally caught on, to the detriment of the financial world. If it weren't for these numbers it would have been very difficult to establish the criteria for the no-doc and liar loans.
3. When credit scoring was re-established in early 90's the formula and scoring criteria was a secret. I was told by TRW now Equifax that this info was under copywrite. No one was supposed to know how to utilize credit to optimize score.

[Vishan Chopra]

What's the best and easiest way to get my score? And do you recommend getting credit monitoring?

[Sarah]

(1) Closing an account does not eliminate the history associated with that account. It will "age off" your record in seven years just as it would if the account were still open. It is true that closing an account *may* reduce the average length you've held a card or the longest time you've held a card; it may also increase your utilization. Both of these might reduce your credit score. But it doesn't "wip[e] away that long credit history."

(2) Your own analysis has nothing to do with taking advantage of discounts when you open store credit cards. Opening many accounts will ding your score. Spending more than you ought *might* affect your score. Whether you use the discount once you've already decided to open the account doesn't affect your score at all (except possibly *positively*--lower utilization because of the discount).

(3) Since whatever account you apply your extra money to, your *overall* utilization won't change, choosing to pay the highest balance account first shouldn't directly affect your credit report.

There are several errors about credit scores here and also some basic inability to distinguish between activities that are potentially harmful to your overall finances and those that will actually directly lower your credit score. Quality control, FMF...your own posts are so much better than your guest posts most of the time.

[Matt Wallion]

Actually Sarah the article is right on with its information. Might I suggest a little more leg work by you before knocking other peoples work.

[Ann-Marie Murphy]

Thanks for the comments -- and keep 'em coming! Sarah, my post was meant to help people better understand not only their credit, but their overall financial know-how. Sure, some of the things I mention won't directly affect your credit score, but it speaks to a larger issue and a broader understanding of your money, debt, credit and spending habits.

All of the experiences here are true and real. Closing that credit card with a long history did in fact ding my score by lessening the average credit card history length. Opening many cards at once hit my score as well. I didn't say that taking advantage of a retail store discount by opening a credit line would affect a score, rather that those offers can be enticing and can lead folks (ahem, me) to make bad decisions about opening credit cards they don't need. Lastly, if you'll notice in my points about paying down the cards with the highest balances first -- I say that in the long-term, your credit will thank you because you'll pay down your balances faster (not that paying certain cards down first will directly and immediately affect one's credit).

Vishan -- you can get a free copy of your credit report and score from Quizzle.com. We'll give you a full Experian credit report so you can check for errors and make sure everything's there that should be there. We'll also give you a free credit score so you can make better sense of all the stuff that's on your report. As for monitoring -- that's up to you. I think it's useful for folks who expect to make some big purchases in the short-term (like buy a home, refinance or buy/lease a car), but generally, if you set reminders to check your credit every six months to a year, you should be in good shape.

[JerryB]

Vishan, the only Federally sanctioned credit report website is http://www.annualcreditreport.com/
It's free. You do have to give your information, but you don't have to sign up for some credit reporting/monitoring/financial management service to get it.
Ann-Marie and FMF, while I agree with a lot of what you wrote, shame on both of you for not mentioning annualcreditreport.com as the place to get your free credit reports.

[HouseofG]

Amen, Jerry. That website should be part of any post about checking your credit score!

Now...what to do about that Chase Rewards card that is about to kick in with a $30 fee after the first year waiver! Guess I'd rather take the ding by closing it than paying a fee on a card I never use now due to the awesome Schwab Visa that FMF clued me into (right before spending a lot of money abroad with currency conversions galore, I might add)!

[rbk]

Maria,

While you may have issues with credit scores or the secrecy of their calculations, they are the single best way to determine who is most likely to cost a lender money and who is most likely to pay on time, every time, until the debt is paid. Until you come up with a better method than this quantitative one, lenders will continue to use these scores to successfully evaluate the risk of their borrowers.

Also, TRW is now Experian, not Equifax. I use to work for them.

I agree with you that misreporting by lenders is a problem and I have seen it firsthand on the back end (from the credit bureau's side). I would not agree that the lenders have all the power, as the FCRA did a lot to protect consumers. Could we do more by better enforcing reporting standards? Probably so. For one thing, the Bureaus should unify data standards and all lenders should report using the same system. But that's easier said than done.

Until you have seen the results of a good credit score firsthand you probably cannot appreciate how well these things work. They do a remarkable job of sorting people according to risk, and 99.9% of the time the reasons why scores behave as they do makes perfect, logical sense if you give it a bit of thought.

One last comment on the secrecy of scoring models-- the reasons for this have nothing to do with lenders or the credit bureaus. It has everything to do with the fact that a credit score is a SERVICE provided to lenders at a cost. Fair, Isaac, Scorex (Experian's scoring shop) and any other business in that field is in it to make money by having the top performing score-- which lenders will pay more for to get the best assessment of risk. You don't get far if you make all your secrets public. Fair, Isaac dominates the scoring business and has a lot of power.

[Ann-Marie Murphy]

Jerry -- I didn't mention AnnualCreditReport.com because my post was meant to highlight my own personal experiences and pass along some of the things I learned to others. I also find credit reports without scores -- because Uncle Sam doesn't give you a score for free -- to be confusing to the average person. It's like getting being in school and getting an exam back without a grade. Most folks wouldn't know what to make of it. There are other places out there that will give you both a full credit report AND score for free with no strings attached.

[Liz]

I thought I heard that when a mortgage lender pulls your credit, it should not affect your score as much as another creditor would. I'm not sure how this would work - as in, does it affect it less somehow. Does anyone know? Thanks!

[rbk]

Liz,

A mortgage lender pulling your credit still counts as a hard inquiry. However, you are allowed to "rate shop" without it hurting your credit. This means if you have multiple inquiries by mortgage lenders within a certain time period, the credit bureaus will only count it as 1 when calculating your score-- meaning you can find the best rate without worrying about your credit. The same is true to a lesser extent with auto loans. So you do get hurt less by multiple inquiries, but a single inquiry will still be counted.

[David]

Ann-Marie Murphy said:
"There are other places out there that will give you both a full credit report AND score for free with no strings attached."

Free FICO scores?
Could you post some links here, please?
Any recommendations?

[Liz Pulliam Weston]

Some thoughts:

Drawing conclusions on how credit scores worked based only on your own experience is problematic, since the same action can affect different people different ways, based on what else is in their credit files.

Ann-Marie's absolutely right about #1. The primary negative impact from closing accounts is its effect on your credit utilization. There is a smaller effect on credit history but your accounts can remain on your report for 10 years or more and still contribute positively to your history, even if closed.

That said, credit utilization is why paying down your highest balance IS a good idea, since that increases the all-important gap between the credit you're using and your available credit. Such credit utilization is 30% of the average FICO score. That's why I advise anyone who's maxed out an account to pay that one down first.

You can get free scores from several sources, including Credit Karma, but they're probably not FICO scores, which is the formula most lenders use. The free scores may be close enough for general education, but if you're going to be in the market for a major loan, I'd suggest paying for your scores at MyFico.com.

We've learned a lot about credit scoring since the dark days when the bureaus and lenders weren't even supposed to tell you that you had credit scores, let alone what they were, but unfortunately lots of myths still abound.

[Liz]

Thanks rbk!

[Ann-Marie Murphy]

David -- As I mentioned previously, you can get a free and full Experian credit report and score from Quizzle.com. No catches. No strings. In fact, no SS# or credit card required.

Thanks all for your comments! I enjoyed guest posting, as well as the coversation that followed. FMF - you have fantastic readers!

[jigwashere]

I work for a bank. My wife and I each have 2 credit cards: 1 primary (through my employer) and one secondary. My wife added me to her primary credit card to take advantage of my employee discount and other benefits.

I would like to cancel my primary card and share my wife's primary card as one step toward simplifying our finances. Am I risking a lower credit score by canceling my card?