For too many consumers, credit scores and their calculation represent a hopeless maze. Lacking a firm grasp of how credit scores work in general, it often appears that your score is the product of credit card voodoo. And while some of us manage to wrap our minds around it, others simply give up hope of ever fully understanding what determines their score. To be sure, some of the problem is lack of financial education. But another obstacle is how seemingly positive or irrelevant behaviors can actually worsen your credit score. Knowing the full truth about these counter-intuitive credit score threats can mean the difference between high scores and financial ruin. Today, BillShrink examines 12 bizarre things that, contrary to common sense, actually harm your credit score.
Closing Cards or Accounts
People who are saddled with consumer debt often find themselves scurrying for some way — any way — to reduce the damage done to their credit scores. At some point, it occurs to them that closing unused credit cards or accounts will help. After all, they assume, the problem is that they appear on paper to be debt risks. From this, they reason that closing a few cards limits their theoretical exposure to debt and therefore makes the debt they do owe look smaller compared to the mighty whole. Unfortunately, the credit bureaus (and creditors who examine your credit report) have almost the exact opposite view of the situation. When your credit score is calculated, it is not just your total outstanding debt that is considered but how much of your available credit you are using. Let’s say, for instance, that you owe $10,000 of a possible $50,000 that you could, in theory, spend. Closing accounts and lowering your available credit to $20,000 does not reassure creditors that you are less of a debt risk. Instead, they see that you were previously using only 1/5 of your available credit and are now using half! In other words, what appears to you to be a perfectly responsible behavior in light of your financial situation can, in fact, worsen your financial situation considerably — beginning with your credit score.
Another solution frequently pitched to consumers as a debt cure is debt settlement, which refers to any arrangement where a creditor agrees to erase your debt for less than you owe. But while debt settlement is infinitely preferable to letting the debt go unresolved, it is not without consequence to your credit score. As MSN explains, a debt removed from your credit report via debt settlement is not scored identically to a debt you paid in full per the terms of your contract with that creditor. Rather, it is made clear that you had to settle for less than the full amount you owed, which acts as a sort of “red flag” to other creditors who might evaluate your creditworthiness in the future. Unfortunately, most of the debt settlement companies that advertise to indebted consumers fail to mention this in their promotions. Consequently, the consumers in question often assume that a repaid debt is a repaid debt and go about their lives unaware of the credit score damage that was done until they need to use their credit.
For similar reasons, setting up a payment plan to repay an outstanding debt can also drop your credit score significantly. The reason is that, as explained above, a repaid debt is not a repaid debt in the eyes of credit bureaus and creditors. Although the debt is being paid off, creditors look at payment plans and see the costs involved. Setting up and administering debt payment plans involves more (sometimes substantially more) overhead, paperwork processing, and customer service than if you simply paid your bills on time. Prospective creditors, therefore, will see that you needed a payment plan to pay off your debts and forecast the risks this would pose if you required similar assistance from them. Consumers often object that this is unfair because ultimately, they are paying off their debt somehow, which is better than not paying it off. However, it is simply the way credit bureaus operate, and it’s better to know the truth than not know.
Inquiring About Old Debts
If you have an old debt or bill from your past, it may actually be better for your credit score if you never attempt to repay it. All states places what are known as statutes of limitations, which specify the number of years a creditor has to legally pursue you for unpaid debts. This number varies state by state and by whether the debt is an oral agreement, written contract, promissory note or open contract. CardReport.com breaks down the various statutes here. Once the statute expires, the creditor may no longer pursue you for the debt. But MSN reveals that “even inquiring about an old debt can restart the statute of limitations in some states, allowing creditors to sue you” for the debt in question. Here, again, the results are counter-intuitive, because what appears to be a good-faith behavior (attempting to make good on an old debt) can actually end up reducing your credit score substantially — and for a substantial period of time.
Having Your Credit Limit Lowered
It’s becoming more and more common (especially since the start of the recession) for banks to reduce credit limits seemingly out of nowhere. But contrary to popular belief, a reduced credit limit is far more than a mere personal inconvenience. As we discussed earlier, a lower credit limit makes outstanding debt look worse because it now consumes a great share of that limit. In fact, About.com reveals that this accounts for 30% of your score by itself. Beyond that, however, having your credit limit reduces is virtually always seen as a poor reflection on the consumer. Other creditors could wonder what you did to have some of your available credit revoked, even if the reasons are wholly unrelated to your behavior. Do not, as some consumers do, assume that the reduced limit is personally burdensome but positive for credit score purposes. It is both personally burdensome and a detriment to your credit score.
Paying Off a Collections Account
If you have been delinquent in paying off a debt for six months, the creditor reports this to credit bureaus as a “charge-off.” But as Ultimate Credit Handbook author Gerri Detweiler, a charge-off is simply a book-keeping term that in no way means your debt is erased. You are still obligated to pay, and will usually begin hearing from collections agencies (to whom the original creditor sold your outstanding debt in order to wash their hands of it.) However, it’s important to know that what counts from a credit score standpoint is what the original creditor reports you owing at the time of charge-off, not what the collections agency subsequently reports you owing. In other words, if your balance is zero at the time a collections agency begins reporting (which is a common scenario) you actually will not improve your credit score at all by paying them anything. Fair Issac spokesman Craig Watts concurs that “if the trade line balance is showing zero, you’re not going to help your FICO score by paying off a collections account.”
Like many debt repayment “solutions”, balance transfers can have their benefits outweighed by unexpected damage to your credit score. The potential risk arises out of the fact that credit inquiries (that is, when third parties pull your credit report for evaluation) account for 10% of your credit score, according to About.com. Given that each inquiry only dings your score by about 5 points, a single balance transfer is not likely to do serious harm. Be weary, though, of rapidly cycling through balance transfers the way that some credit card users have taken to doing in recent years. Five transfers, by FICOs measure, could reduce your score by 25 points all by itself.
Neglecting Old Debts
We advised earlier that attempting to repay old debts can harm your credit score. That is still true. However, it is also true that simply letting old debts fade into the sunset can harm your score. How can both be true? Basically, because FICO’s credit scoring formulas group consumers into categories of shared characteristics, like whether you’ve ever gone bankrupt. Once the bankruptcy vanishes from your report (a good thing, all else equal), FICO’s formulas could shift you over to a different category, where you rank lower than you ranked in the bankruptcy category. This is another reason that some consumers find their credit score has dropped by, in some cases, dozens of points for seemingly no reason. While it is not certain that the removal of old debts will transfer you to a different category (or to a different category that reduces your score) the possibility is there and you should be mindful of it.
Canceling Older Cards
We’ve already discussed the negative impact that closing credit cards can have on your credit score if you are in debt. Unfortunately, the damage does not end there. If you closed an older credit card, your credit score will likely suffer even more. That’s because FICO’s credit scoring formulas prefer older sources of credit. Unlike a credit card you got approved for last week, an older card in good standing serves as evidence that you have used that card responsibly for a lengthy period of time. Bankrate.com concurs, explaining that “by canceling an old card, the length of your credit history on open accounts will grow shorter.” Therefore, if you determine in the face of the information in this article that you still must close a credit card, strive to make it a newer card rather than an older one.
HowISaveMoney.net reports a potential credit score threat that few people are aware of: library card fines. Believe it or not, late book rentals and other past-due library fees are sometimes reported to credit bureaus, after which they become entries on your credit report. While such infractions typically amount to “a “a slap on the wrist for negligent people”, consumers should be aware that “the few points that they take off your score can really add up over time.” It’s not likely that library fines will irreparably damage your score, but it is worth knowing in light of the fact that scores seem to change abruptly and without explanation.
Using “Limitless” Credit Cards
Some consumers have what are known as “limitless” cards, which, in practical terms, mean that the card issuer does not report the card’s limit to credit bureaus. At first glance, this might seem like a good thing. If the credit bureaus don’t know your score, after all, your used credit to available credit ratio can’t be all that bad. Sadly, this is not how things play out in reality. What the credit bureaus typically do instead of use the highest balance you have ever had on your “limitless” card and set that as your limit. If you’ve been reading along, you should already see the problem. If you’ve only ever charged $500 on the account and owe $400, your used credit to available credit ratio will look awful as far as your credit score is concerned.
Unpaid Parking Tickets
Increasingly, consumers are finding that no unpaid obligation is safe from the credit score calculator. As CNN noted back in 2006, local governments are now passing off your unpaid parking tickets to collections agencies who, just like collections agencies working on behalf of your creditors, can report negative information like non-payment or late payment to the credit bureaus. Amazingly, CNN says, a report to credit bureaus by the collections agencies stating that you failed to pay overdue parking tickets “could drop your credit rating by 100 [points] or more.”