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Intuition and common sense can let you down big time if you use them to make credit decisions.
Consumer credit expert John Ulzheimer says the secret is to understand the factors behind your credit score and use those to guide decisions.
Here are five perfectly reasonable-sounding credit moves that can come back to bite you — and what to do instead.
1. Assuming that paying on time is enough for a good score
If you’re routinely charging a large chunk of your credit limit on a card, paying your bill in full every month may not help your credit score as much as you think it will.
Paying on time is just one of two major influences on your score. The other is “credit utilization,” the portion of your credit card limits you’re using. Experts suggest using no more than 30% of the limit on any card, and lower is better.
Using credit lightly demonstrates responsible borrowing to lenders, explains Amy Thomann, head of consumer credit education at TransUnion, a credit bureau. But high credit utilization is “predictive of risk,” Ulzheimer says, and hurts your score.
What to do instead: Make sure your credit utilization stays below 30% throughout the billing cycle. You can make multiple small payments throughout the month to keep the balance consistently low relative to your limit.
2. Closing a credit card
You may think a credit card that sits in a drawer unused is just clutter and decide to close it. But it can still help your credit. And the higher its credit limit, the more it helps. That’s because your total credit utilization matters as well as per-card credit usage.
Closing a credit card can hurt your score two ways: It reduces your overall credit limit, which can send your overall utilization up. It may also reduce the average age of your accounts, which can ding your score to a smaller extent.
What to do instead: Keep credit cards open, unless you have a compelling reason to close them. “If you don’t need a credit card, but it has a high credit limit or has been open a long time, you might want to keep it open and use it to make small purchases that you pay off on time,” Thomann says. Regular use guards against the issuer closing the account for inactivity.
3. Paying off a loan early
If you can pay off your loan and get it done early, what’s not to like about you as a credit customer? But don’t expect the credit gods to cheer.
Paying a loan early has no effect on your credit score. But having fewer credit accounts can hurt by reducing the overall age and mix of your accounts.
What to do instead: Focus on what’s best for your finances. If you have a 0% loan, there’s not a lot of incentive to pay early. If you have a loan charging 29% interest, though, there is. The potential for a dip in your score from having one fewer credit accounts is not a good reason to continue to pay a lot of interest if you can avoid it.
4. Sending in a partial payment
There is a persistent myth that paying something — even if you cannot pay the minimum — will keep you from being sent to collections. It makes sense to believe a creditor would rather have a partial payment than nothing.
But that strategy won’t keep you out of collections. It won’t even keep you from being reported late. If you don’t pay at least the minimum by 30 days past the due date, the creditor can report your account as delinquent to the credit bureaus.
What to do instead: If you are unable to pay even the minimums, talk with a nonprofit credit counselor.
5. Rejecting a higher credit limit
The more available credit you have, the more likely you are to go into debt, right? That’s not what the data shows, and credit scores are all about statistics and probability. A higher credit limit is generally a good thing unless you’re sure it will tempt you to overspend.
What to do instead: Accept the higher limit and keep your spending steady. That will lower your credit utilization.
3 simple rules
Building credit can sound complicated because there are several factors, and they interact. But knowing what’s important, and acting accordingly, can get you a good score.
Just follow three rules:
- Pay on time, every time.
- Use less than 30% of your credit limits.
- Keep an eye on everything else.
“Everything else” means the accuracy of your credit reports, the age of your credit, whether you have both credit cards and loans, and how many. But those factors matter much less than paying on time and keeping credit utilization low.