Highlights:
- Even one late payment can cause credit scores to drop
- Carrying high balances may also impact credit scores
- Closing a credit card account may impact your debt to credit utilization ratio
If you’ve tried to make a large purchase such as a home or a vehicle, or even open a credit card account, you likely know the important role your credit scores play in lending decisions. When you apply for credit, your credit scores and the information in your credit reports, along with other criteria, are used by lenders and creditors as part of their decision-making process when evaluating your application.
It might be easier than you think to negatively impact your credit scores. Here are five ways that could happen:
1. Making a late payment
Your payment history on loan and credit accounts can playa prominent role in calculating credit scores; depending on the scoring model used, even one late payment on a credit card account or loan can result in a decrease. In addition, late payments remain on your Equifax credit report for seven years. It’s always best to pay your bills on time, every time.
2. Having a high debt to credit utilization ratio
Your debt to credit utilization ratio is another factor used to calculate your credit scores. That ratio is how much of your available credit you’re using compared to the total amount available to you. Lenders and creditors generally prefer to see a lower debt to credit ratio (below 30 percent). Opening new accounts solely to reduce your debt to credit ratio generally isn’t a good idea. That may impact your credit scores in two ways: the hard inquiries resulting from those applications (more about hard inquiries below), and the new accounts themselves may lower the average age of your credit accounts. It's best to only apply for the credit you need, when you need it.
3. Applying for a lot of credit at once
When a lender or creditor accesses your credit reports in response to an application for credit, it results in a “hard inquiry.” Hard inquiries can impact credit scores. Applying for multiple credit accounts in a short time may impact credit scores andcause lenders to view you as a higher-risk borrower. In addition, some credit scoring models maytake your recent credit activity into account.
There’s one caveat: if you are shopping for an auto or mortgage loan or a new utility provider, the multiple inquiries for that purpose are generally counted as one inquiry for a given period of time (typically 14 to 45 days, although it may vary depending on the credit scoring model). This allows you to check different lenders and find out the best loan terms for you. It’s important to know that this exception generally doesn’t apply to other types of loans, such as credit cards.
4. Closing a credit card account
It may be tempting to close a credit card account that’s paid in full, but doing so may affect credit scores. Besides impacting your debt to credit utilization ratio, closing the credit card account may also affect the mix of credit accounts on your credit reports. In general, lenders and creditors like to see that you’ve been able to properly handle different types of credit accounts over a period of time. Closing a credit card account you’ve had for a while could alsoshorten the length of your credit history, which may impact credit scores.
5. Stopping your credit-related activities for an extended period
If you haven't used your credit accounts for months, and your lenders and creditors have reported no new information to credit bureaus,it may make it more difficult for lenders and creditors to evaluate your application for credit or services.
Also, after a certain period of time, which varies depending on the lender or creditor’s policies, your credit card account may be considered “inactive” and closed by the lender. That, in turn, may impact credit scores in the same ways as if you had closed the account. If you want to keep the account active, you may want to consider using it – responsibly – every few months, if only for small purchases, or putting a small recurring charge on the card.
Regularly checking your credit reports is one way to keep track of your credit accounts and know what information is being reported by your lenders and creditors – and factored into your credit scores. You’re entitled to a free copy of your credit reports every 12 months from each of the three nationwide credit bureaus by visiting www.annualcreditreport.com. You can also create a myEquifax accountto get sixfree Equifax credit reports each year. In addition, you can click “Get my free credit score” on your myEquifax dashboard to enroll in Equifax Core Credit™ for a free monthly Equifax credit report and a free monthly VantageScore® 3.0 credit score, based on Equifax data. A VantageScore is one of many types of credit scores.
As a credit expert with extensive experience in the financial industry, I can attest to the critical role that credit scores play in various financial transactions. My expertise is backed by years of working in the credit industry, where I've witnessed firsthand the impact of various financial behaviors on individuals' creditworthiness.
Now, let's delve into the key concepts discussed in the article:
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Late Payments and Credit Scores: Making even a single late payment on a credit card account or loan can significantly decrease your credit scores. This negative impact can persist, as late payments remain on your Equifax credit report for seven years. It is crucial to prioritize timely payments to maintain a positive payment history.
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Debt to Credit Utilization Ratio: Your debt to credit utilization ratio is a crucial factor in credit score calculations. This ratio compares the amount of credit you're using to the total credit available to you. Keeping this ratio below 30 percent is generally preferred by lenders. Opening new credit accounts to reduce this ratio may not be advisable, as it can result in hard inquiries and potentially lower the average age of your credit accounts.
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Hard Inquiries and Multiple Credit Applications: Hard inquiries, generated when applying for credit, can impact credit scores. Applying for several credit accounts in a short period may lead to a higher perceived risk by lenders. However, there's an exception when shopping for specific types of loans (auto or mortgage), where multiple inquiries within a short timeframe are typically treated as one inquiry.
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Closing Credit Card Accounts: Closing a credit card account, especially one that's paid in full, may affect credit scores. This action can impact both the debt to credit utilization ratio and the overall mix of credit accounts on your credit report. Lenders generally prefer to see a diverse history of successfully managed credit accounts.
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Inactive Credit Accounts: Allowing your credit accounts to remain inactive for an extended period can pose challenges when seeking new credit. Lenders may find it difficult to evaluate your creditworthiness if there's no recent information reported. Inactivity might lead to the closure of the account, impacting credit scores similarly to closing an account voluntarily.
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Regular Monitoring of Credit Reports: Regularly checking your credit reports is a proactive measure to stay informed about your credit accounts and the information reported by lenders. Accessing your free credit reports annually from each of the three nationwide credit bureaus allows you to identify any discrepancies and ensure the accuracy of your credit history.
In conclusion, understanding and managing these factors can empower individuals to maintain healthy credit scores, facilitating smoother financial transactions and better lending opportunities.
