Improving your credit score is always a smart goal. Better credit means lenders will offer you lower borrowing costs, more advantageous loan terms, and bigger lines of credit.
Unfortunately, it's easy to make mistakes when you're trying to boost your credit score—and some errors can actually cost you money and cause your score to go down. To keep your credit score on an upward trajectory, avoid these 5 common errors.
1. Closing credit accounts
It's generally responsible to limit your credit card usage, which is why many people assume they can boost their credit scores by closing old cards. Unfortunately, the opposite is true. Closing accounts can hurt your credit score in a few different ways.
When you close an old credit card, you reduce the total amount of credit available to you. This is a problem because credit utilization accounts for 30% of your credit score. Credit utilization is the percentage of your available credit that you use. Experts typically recommend keeping your credit utilization below 30% of your available credit.
As an example, say you have a card with a $2,500 balance and a $5,000 limit, and you also have an old card with a $0 balance and a $5,000 limit. Here's how you would calculate your credit utilization ratio:
Total credit available = $5,000 + $5,000 = $10,000
Credit utilization = $2,500 + $0 = $2,500
Credit utilization ratio = $2,500 / $10,000 = 25%
Your credit utilization ratio would be a healthy 25%. If you were to close your old card, however, then you'd suddenly be using $2,500 of your $5,000 in total available credit. Your new 50% utilization ratio would suddenly be far above the recommended 30%.
Closing old cards also causes another problem. Another 15% of your credit score is determined by the length of your credit history. A longer history is preferable, because it shows you've been dealing with debt responsibly for a long time. Closing older accounts will reduce the average age of your accounts.
2. Opening too many new accounts at once
One of the great ironies of the credit scoring system is that you must have credit to build credit.
Because having access to credit is essential to a good score, it may seem smart to open lots of accounts. Unfortunately, opening too many new accounts at once can backfire on you. First of all, new accounts lower the average age of your credit, which we already know is a bad thing.
On top of that, each time you apply for a new account, a creditor checks your credit, and this credit check counts as a "hard inquiry" on your credit report. Inquiries for new credit account for 10% of your credit score, and each hard inquiry causes your score to drop by a few points. This adds up when you have lots of inquiries.
3. Carrying a balance and paying interest
If every single credit card holder paid their bill in full every month, then the entire credit card industry would go under. These companies need customers to carry balances from month to month and pay interest on them—and those interest payments can be extremely lucrative, given the double-digit interest rates on credit card debt. That's why so many people assume they need to carry a balance in order to get on lenders' good sides and raise their credit score.
But that's a misconception that could cost you dearly. You get no extra boost to your score for allowing a balance to carry forward from one month to the next, and the interest payments are a waste of money.
That said, it is vital to establish a track record of paying your bills on time, as your payment history accounts for 35% of your credit score. This metric, more than any other, reflects your ability to repay your debts, which is why it's such a huge factor in your FICO score.
4. Trying to apply for credit that you won't get approved for
To build up your history of on-time payments, you obviously need to have at least one loan or credit card you can pay... but what if you don't have any access to credit?
Don't just start applying for loans or cards until you find someone to lend to you. If you apply for credit and are denied, the denial doesn't show up on your credit report but the inquiry does... even if you aren't actually given a loan or new card.
Rather than risking a bunch of inquiries on your report for loans and cards you don't get approved for, apply for a secured credit card to get access to credit.
You should be approved for a secured card even with really bad credit since you must put up collateral. If you get a secured card with a $500 line of credit, you'd put up $500 in cash to guarantee you'll pay back the debt.
Research secured cards carefully and apply for just one to limit inquiries. Make sure the card has low fees or no fees and make sure the card issuer reports to the three major credit reporting bureaus so your on-time payments will show up in your payment history.
5. Charging up a big balance on any credit card
While making on-time payments on at least one debt is essential, a bigger balance is not better. There is no reason to charge a large amount of money on any credit card, and doing so is more likely to hurt your credit score than to help it.
If you rack up a large balance, this could push your credit utilization up above the recommended 30% ratio. You could also get stuck with the balance and interest if you find yourself unable to pay the debt in full. There is no payoff for taking that risk.
If you already have a big balance and are using more than 30% of your available credit, then your best move for both your score and your wallet is to pay down the balance as quickly as possible.
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Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917