Many extremely responsible consumers have credit scores that do not accurately reflect their credit worthiness. Most of the time, it’s not because they fail to pay their bills on time. It’s because they inadvertently do things that make financial sense but hurt their FICO scores. How can that be? If you follow the Credit Monkey regularly, you know that things that make sound financial sense don’t always result in higher credit scores. To help you avoid credit score sapping pitfalls, the Credit Monkey’s assembled 9 Simple Rules to Maintain a High Credit Score.
RULE #1: Be Careful When Opening New Credit Card Accounts to Transfer Balances for Lower Interest Rates
This practice can lower your credit score faster than any other missteps except for making late payments. The draw of low interest rate credit cards makes financial sense, especially when trying to dig out of debt. Unfortunately, the FICO scoring model doesn’t care about what makes financial sense. It only cares about predicting if you can pay your future bills.
Accordingly, if your credit score is as important to you as debt reduction, then act judiciously when opening new accounts. Here’s why. Applying for a new credit card triggers at least three events that lowers your credit score. First, your credit is pulled by the credit card issuer. A typical reduction for a new credit pull could be as much as five points. While that reduction normally only lasts a couple of months, it could last up to twelve months, depending on your circumstances.
A second reduction occurs when the new credit line appears on your credit report. The FICO scoring model automatically assumes your new credit card may adversely affect your ability to pay your future debt. So, bam. FICO hits you with another credit score reduction of five to twenty points. That reduction could last up to six months.
Finally, a new credit card will usually affect your debt to available credit ratio. In the industry, that’s called Credit Utilization. (Read the Monkey’s post titled the Five Categories of Credit Scoring for a more detailed explanation of credit utilization. Depending on your other credit card balances, a new credit card can change your credit utilization and reduce your credit score.
The application process for a new credit card and how issuers report the new credit line to the credit bureaus may negatively affect your credit score. You could lose ten to fifteen points for a few months because the transferred balance may appear on both the old credit card and the new credit card at the same time.
You should also be aware of another major credit score reducer related to balance transfers that could affect your credit score far longer than a few months. When you get the new, low interest credit card, you will probably max it out your new, transferring balances from your high interest credit cards. It makes sense. Right?
Remember that a maxed credit card will reduce your credit score for as long as the card balance is anywhere near its limit. If you transfer balances from other cards to make your payments more affordable rather than as a tool to reduce your debt, it will probably take you some time to pay down the high balance. Accordingly, your credit score will be bruised for as long as you carry a high balance on the new credit card. That’s the credit utilization trap.
RULE #2: Avoid Closing Old Accounts.
The rule of thumb is, keep the average age of your open credit accounts at five years or more. On their websites, the major credit bureaus specify five years account aging as a pivotal scoring number. The Credit Monkey’s experience with credit repair also confirms that five years is a key to an over-the-top credit score.
Don’t let the old accounts disappear as you pay them off. Use the account occasionally and let it work to improve your credit score. (See Length of Credit History in Five Categories of Credit Scoring mentioned above.)
RULE #3: Limit Loan Applications When Shopping for the Best Rate.
The most recent FICO Scoring Model encourages rate shopping for mortgages and automobile loans. It permits different mortgage and car lenders to pull your credit report a total of three times during any thirty-day period. The three rate shopping pulls count as only one when calculating your credit score.
The Federal Trade Commission (FTC) mandated the three credit report pull rule to encourage consumer rate shopping. It’s one of the best new credit scoring rules that no one knows about. The Monkey believes in it. Rate shopping is good for business.
Even with this rule, homebuyers rarely shop lenders after they start the mortgage process. They either shop before their credit report is pulled using advertised rates or they rely on their personal bank or Realtor’s lender recommendation for a competitive rate.
On the other side of the coin, car buyers tend to do more damage to their credit score when shopping for loans than do mortgage rate shoppers. Why? Because automobile purchasers with multiple credit pulls are not truly rate shopping. They are approval shopping.
A consumer shopping for a car with marginal credit will usually accept the first approval offered. They need a car regardless of its cost. So, they sign on the line. “Press hard. The bottom copy is yours.”
Experience shows that if a consumer gets declined three times, he usually won’t get approved for a car loan by a traditional lender. Despite that knowledge, automobile dealers continue to damage consumer’s credit scores by shopping dozens of lenders for the marginal buyer hoping to get lucky.
Each prospective lender pulls a credit report. After three pulls, the consumer’s credit score drops with each successive pull. After a few declines and a further reduction in credit score, it becomes almost impossible for the marginal borrower to get approved by a traditional lender.
RULE #4: Don’t Open Retail Credit Accounts for a One-Time Discount.
The three credit report pull rule doesn’t apply to credit cards. Therefore, the Be Careful When Opening New Credit Card Accounts to Transfer Balances for Lower Rate Credit Cards rule applies.
When you open an account for a one-time discount, you are essentially opening an account to reduce your cost. That’s great. The problem is that the consumer product purchased wears out or is thrown away while the credit card account may last forever.
Think long term. The resultant reduction in your credit score from opening another new credit card account may cost you more long term because of the real cost of a lower credit score than the money saved on a consumer product.
Additionally, the Enough Is Enough rule below applies.
RULE #5: Keep Credit Card Balances Low. Have Only One Account With a High Balance.
It makes financial sense to avoid interest charges, especially on high-rate credit cards. Depending upon your credit card usage, paying the account balance to zero every month could save you thousands of dollars in interest every year.
Unfortunately, zero balance credit card accounts do not produce the highest credit scores. Owning a few accounts with twenty to thirty percent credit utilization yields higher credit scores than does many accounts with zero balances. Why? It’s another one of those fickle twists of the scoring model meant to anticipate your ability to pay future bills.
However, there is a way to balance the financial common sense of little or no debt with the need to maintain an excellent credit score. Here’s how:
Keep little or no balances on all your cards except one. On that credit card, keep a higher balance, perhaps fifty to sixty percent of the credit line. The card you decide to use should have a low interest rate. Cash back or travel rewards could be exchanged for a low interest rate, depending upon your lifestyle.
Use the card regularly and make significant payments on the balance every month. Remember, the purpose of this card is to keep your credit score high. This rule does not grant permission to use a credit card as an ATM or as a long-term financing substitute so you can buy more toys. It’s only a necessary evil to improve your credit score. Think about it as a tool that lets you manipulate your credit utilization.
If you are debt free, then use one card for as many of your month-to-month purchases and bill paying as you can. At the end of month, pay the entire balance on that credit card. Using a single card in this manner this tells the FICO scoring model that there is a balance on the card. Technically there is balance, even though you pay it monthly. Credit card billing and reporting falls about thirty days behind reality making it appear that you carry a balance when you don’t.
As suggested earlier, for this rule, use a low interest credit card or one that offers bonuses for usage.
RULE #6: Avoid Closing Accounts Before Paying Them Off.
As mentioned previously, the purpose of credit scoring is to predict your ability to pay future debt based upon your present financial circumstance.
Late payments and high balances are red flags to the FICO scoring model that suggests that a consumer may have trouble paying his future bills. A low credit score tells lenders, “Danger, Danger, Will Robinson.”
Closing an account before it’s paid is another FICO red flag. It screams, “Somethings not right here.” Never let it happen!
RULE #7: Enough Is Enough.
Too many open accounts, even with no or low balances, will lower your credit score. The FICO scoring model considers large numbers of little used accounts as an opportunity for you to overextend. Zap!!! That’s the sound of too many open accounts hitting your credit score. Enough is Enough and enough is too much. Do you really need six or more credit cards?
RULE #8: Make Payments on Time.
Skipping a month, paying late, or paying less than the minimum monthly payment is the biggest credit scoring red flag of all. The Making Payments on Time rule is common sense.
A lone late car payment could cost you twenty to thirty points on your FICO score for up to two years. A late credit card payment up to twenty points. The worst part is, there are no Jedi credit tricks to overcome repeated late payments.
Avoid late payments. Setup autopay and make timely bill paying the top priority on your to do list.
RULE #9: Never Permit a Disputed Charge Go to Collections.
Always correct disputed charges. Never let one hit your credit report.
Correcting a disputed charge could mean a simple debt validation request. It might mean compromising and meeting som ewhere in the middle with a payment. Or in the end, it could come down to paying the disputed amount. Whatever it takes, keep collections off your credit report.
Removing a derogatory mark on your credit is more costly in time and money than avoiding it in the first place. If you later pay the collection at a discount, the collection remains on your credit report for seven years. It will show paid, but it still affects your credit a point or two for at least two years.
If you rely on pay and delete; remember, not every collections company will agree to pay and delete. And when they do, it is usually at the price of a complete payment and not a negotiated, discounted pay-off.
Just as building your credit takes effort and mindfulness, so does maintaining the excellent credit score you worked hard to earn. If you follow the Credit Monkey’s 9 Simple Rules to Maintaining a High Credit Score, you will be rewarded with a great credit score for years to come.
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If you liked this post, you may also enjoy reading When Paying Bills Makes Your Credit Score Worse.