I’ve been writing about personal finance and credit cards for years, and one of the countless pieces of information that I’ve gleaned is that the credit building process is largely misunderstood by a lot of people. Credit scores are important because they represent a huge factor when trying to make a large purchase that requires a loan. For example, if you are trying to take out a mortgage to purchase a home, or a loan in order to purchase a car, the first thing a creditor will look at is your credit score.
One of the most common queries I’ve gotten over the years from clients and friends alike centers around how to improve one’s credit score, and how to keep the score maintained once it’s at a healthy level. This post is going to explain the five most common pitfalls people encounter whilst trying to build their credit scores.
- Using more credit than you have available. Not surprisingly, going over your credit limit is the easiest way to harm your credit score. This happens more often to people with lower credit limits, but it can happen to anyone who is not paying attention to their spending. If you are prone to spending a lot without realizing it, I encourage you to start keeping track either with a pen and paper that you keep in your wallet, or with one of the many personal finance smartphone apps currently on the market (my favorite is Mint). Taking this one step further, the general rule for building credit is to use less than 30% of your available credit limit. So, if you have a $10,000 credit limit, then you would want to use less than $3,000 worth of credit per month.
- Paying late. Besides going over your credit limit, paying bills late is the second most common way that people hurt their credit scores. Any late payment to a creditor that reports to the major credit bureaus can and will hurt your score. This includes credit card bills, car payments, mortgage payments, cell phone bills, and more. In order to avoid paying your bills late, I recommend setting up direct deposit with your creditors so that they can automatically deduct the funds from your checking account. If you are not comfortable with this, then there are other ways to be alerted of impending bills such as setting up text or email alerts with your credit card company to alert you before bills are due.
- Applying for too many lines of credit all at once. Another common mistake that people don’t realize can hurt their credit score is applying for credit too many times within a small time-frame. For example, some people make the mistake of applying for a credit card that requires better credit than they have, and then get denied. Instead of finding out their credit score and then applying for a credit card appropriate for them, they go on an applying spree and get denied from several credit cards all at once. These multiple hard inquires on their credit score ends up dragging it down.
- Not monitoring your credit score. One of the easiest ways to make sure your credit score stays healthy is to monitor it constantly. I’m not talking about sitting at your computer staring at it all day, what I mean is signing up for a credit monitoring service such as Citi Identity Monitor. These services are generally very cheap or free, and will alert you if there are any changes to your credit score or identity theft attempts. In addition, many services provide customized suggestions on how to improve your credit score, and highlight which factors are currently dragging your score down.
- Closing really old credit card accounts. Many people don’t realize that your credit score draws from years and years of your credit history. If you close one of your old credit cards, then you are effectively wiping the positive factors associated with that account from your credit score, as well as shortening your credit history. In addition, closing an old credit card usually lowers your overall credit limit, which increases your utilization rate, which can also lower your score. If your old credit cards don’t have an annual fee, then there is really no point to closing the accounts. However, if you are being subjected to a high annual fee each year for a credit card you don’t use, then that’s a good reason to close the card.