What Affects Your Credit Score

I use ING Direct for my savings accounts, partially because I earn 1.4% APR on my accounts, partially because their site and accounts are user friendly, and partially because they charge no fees. Ever. (I further discuss savings accounts in Personal Finance Basics: Save the Difference).

But that’s not the point of this page.

The point of this page is that I get ING Direct’s “We, the Savers” newsletter, and this week they talked about credit scores, and what financial behaviors can negatively affect your score. (The link takes you to a quiz, where you can test your knowledge on what negatively affects your score. If you want to know the answers without taking the quiz, just scroll down.)

Since I already wrote about why it’s important to know your credit score, I thought I would share with you their insights as well.

Financial behaviors that can negatively affect your credit score, and a brief explanation as to why

  1. Applying for a new credit card – In the process of applying for a new card, the new credit card company will request your credit score and report, and each new request lowers your credit score (although this is often temporary, and will adjust out in a month or two).
  2. Lowering your credit limit – When you lower your credit limit on any card, it lowers your available credit, and the smaller the gap is between your available credit and your credit balance, the worse your credit score becomes.

    • Example: Say you have a balance (i.e., you owe) $1,000 on a credit card with a credit limit of $3,000. The difference there is $2,000, which means that you’re only using 33% of your available credit. That’s not bad, all things considered (0% would be better, of course, but you already know that). But if you were to lower your credit limit from $3,000 to $2,000, then you would be using 50% of your available credit, which doesn’t look as good. And if you lowered your limit even further, to $1,200, then you be using 83% of your available credit, which is even worse.

    Any percentage above 50% reflects negatively on your credit score, and the closer the percentage gets to 100% of your available credit, the worse your score becomes.

  3. Closing old credit card accounts – This affects your credit score for the same reason as lowering the limit on your credit card, because it decreases the gap between your available credit and how much you owe.
  4. Never having a credit card – You wouldn’t think this would negatively affect your score, but having a credit card (and paying it off on time) is one of the fastest ways to build credit. Therefore, conversely, not having a credit card means that you haven’t probably done much to build your credit.
    Without credit, you have no credit history. And without a credit history, lending companies have no way of knowing if you’re a risky investment, or not, so it’s much more difficult to rent an apartment, or get a car loan, or get a mortgage, or, interestingly, even get a credit card. There’s a Catch-22 for you. ^_^
  5. Having a short history of credit – As I said, without a credit history, you can have no credit score, because what would they score? Having no credit history doesn’t so much negatively affect your score, as it precludes it entirely. But again, without a credit score, it’s very difficult to get any sort of loans, and can even affect whether or not you can rent an apartment, so it’s a good idea to find a way to build credit and thereby a credit history.
  6. Exceeding a credit limit – This is the extreme of the whole “available credit to balanced owed” ratio; if you owe more than 100% of your available credit… well, they really don’t like that, as you might imagine
  7. Having a lot of debt – The more debt you have, the greater the possibility that your credit balance will take up more than 50% of your credit available, which, again, lowers your credit score. It is possible to have several thousand, or even tens of thousands of dollars of debt, and have it spread over enough different companies that your score is not as adversely affected, but I don’t recommend that path, because you still have to pay all that debt off.
  8. Paying a mortgage late – If you’re late on a payment, especially a mortgage payment, which is usually a huge loan, it negatively affects your score because it indicates (rightly or wrongly) that you are unreliable, and therefore a risky investment.
  9. Paying bills late – This applies to credit card bills, of course, for the same reason mentioned above, but it also applies to your electric bill, and your cable bill, and your cell phone bill, etc. Any late payment can negatively affect your credit score because they’re all reported, and it shows that you are unreliable, forgetful, or living paycheck to paycheck. All of that spells “bad investment, run away” to credit companies and other lenders. It’s not fair, but them’s the breaks.

    Have no fear, though. If you’re someone who perpetually pays your bills late, you just have to make sure you choose a life-partner who pays the bills instead of you. As my aunt says, “Into every relationship a bill-payer must come.”

So now you know a bit more about what affects your credit score and why, so the next time you get your credit report and score, you can make more sense of it, and in the meantime you know what behaviors to avoid to help your credit score either stay were it is, or improve.

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Know Your Credit Score