A good credit record and score are both important if you want to borrow money at a low interest rate for a personal loan or mortgage, or up your odds of getting approved for the best credit cards. But sometimes even the smartest borrowers make mistakes when it comes to their credit.
Here are ten mistakes you should try to avoid:
1. Ignoring your credit report
It’s best to check your credit report at least once a year to make sure the information is accurate, up-to-date, and there aren’t any mistakes or fraudulent accounts. There can be minor errors, such as incorrect personal information or the misspelling of addresses and names. Or major errors, such as accounts that don’t belong to you or incorrect payment history that could potentially be dragging down your creditworthiness.
If you do spot wrong, incomplete or fraudulent information on your credit report, you can file a dispute with the credit bureaus.
You’ll want to pay particular attention to:
- Wrong account numbers
- Accounts you don’t recognize
- Inaccurate payment status or instances of late payments
- Closed accounts still reported as open
- Duplicates of the same account
- Accounts or information from a former spouse
- Incorrect credit limits
- Reports of delinquencies that are either false or out of date (over 7 – 10 years old)
- A collections account that is either false or has been paid off or settled
You can get your report from the two major credit bureaus (Equifax and TransUnion) once a year for free. You can obtain your report from one bureau first and wait six months to get the report from the other bureau, which may help you spot any problems ahead of time. And remember, checking your own report doesn’t hurt your credit score.
2. Avoiding credit
Not having credit means it’s nearly impossible to go into debt, but it’s equally impossible to buy a home or a car without it unless you intend on paying for either one in full. While it’s nice not to have debt, it can take years—or even decades—to save up for larger purchases. Even renting an apartment can be a problem if you don’t have a credit record since most landlords will request a copy of your credit report.
As long as you make payments on time and pay off your credit card balance in full, you’ll be fine. Being disciplined will help prevent you from being irresponsible and making foolish decisions with your money.
3. Making just one late payment
If you forget to make a payment or make a late payment, neither is good for your credit. At the very least, you should ensure you make the minimum payment each and every month by the due date shown on your credit card statement.
Payment history is the single largest factor that goes into formulating your credit rating, accounting for roughly 35% of your credit score, and even missing just one payment can have serious implications.
One way to avoid ever missing a payment is to set up automatic bill payments from your chequing account to your credit card every month. If you juggle multiple credit cards, scheduling email or calendar alerts can provide a helpful nudge of when payments are due so you don’t lose track.
If you do end up missing a payment, you’ll want to take action right away. Most card issuers will only report late payments after 30 days, so contact your card issuer to inform them of the mistake and pay at least the minimum as soon as possible.
4. Carrying large balances or maxing out your credit card
Credit card issuers give you an amount of available credit. But just because they set a certain limit doesn’t mean you have free reign to use all (or most) of it every month. If you do, you will have a higher credit utilization ratio. And unfortunately, that can be a bad thing.
Owing a large balance or maxing out your credit card can be taken as a sign you’re overleveraged and too dependent on debt, which lenders may associate with risky behaviour even if you do make payments on time. It also means your minimum payments will be higher (and harder to pay off) and you’re more at risk of going over your assigned credit limit, which can result in additional penalties and dings to your credit score.
What’s important to note here is lenders don’t define a “large balance” by the actual dollar amount, but how large the balance is in relation to your total credit limit.
For example, if you have one credit card with a $1,000 limit and you owe $800, your credit utilization ratio will be far from ideal at 80%. But If you have two cards with a combined limit of $2,500 and you owe the same $800 balance, the credit utilization ratio will be a more favourable 32%. In an ideal situation, your credit utilization ratio should be around 30% or less. Having a high credit utilization ratio can have a negative impact on your credit score.
There’s also a common misconception that carrying a balance is good for your credit score. In fact, it could potentially hurt your score because it may impact your credit utilization ratio. The best thing to do is to pay off your balance in full every month. Not only can it potentially help improve your score, but it will also save you from having to pay interest on your purchases.
5. Rejecting a pre-approved credit limit increase
It’s not uncommon for banks to offer an automatic, pre-approved credit limit increase seemingly out of the blue – especially if you’ve been using your credit card responsibly. And while your first instinct might be to reject the offer out of suspicion or the assumption a low limit is always better, you’ll want to think again.
As counterintuitive as it may sound, a higher credit limit can actually be beneficial to your credit score. The reason being is it can help to lower your credit utilization – or in other words, the ratio between the size of your balance and your total credit limit.
As I covered earlier, lenders measure your overall debt load as a percentage of how much you owe relative to your total credit limit – not the actual dollar amount of your balance. So weirdly enough, someone who owes an $800 balance on a card with a limit of $1,000 is actually regarded as riskier and more reliant on debt than someone who carries the same $800 balance but on a card with a limit of $2,500.
All that said, a credit limit increase should always be approached cautiously and will benefit your credit score the most when your spending habits remain unchanged. If you’re worried a higher credit limit may tempt you into increasing your spending or taking on more debt, you’ll want to reconsider accepting the increase.
6. Needlessly closing old accounts
Many people close credit cards they no longer use, especially if it has an annual fee. However, this isn’t always a good idea because lenders look at your credit history to see how much experience you have with credit. Plus, cancelling a credit card can lower your overall credit limit, which as we covered above, can have a negative implication on your credit utilization ratio and credit score.
To be on the safe side, it’s best to keep a card open even if it will go unused. If it’s a no-fee card, it doesn’t cost anything to leave the account open. If you have a card with an annual fee, you can ask your financial institution to waive the fee or switch to a no-fee alternative and transfer over your account history to the new card.
7. Not closing a credit card the smart way
As I covered above, it’s generally better not to close a credit card if you don’t absolutely have to. But if you must, make sure to cancel your credit card the right way.
Pay off any remaining balance owed on the credit card in full and ensure you cancel any recurring payments that are set to automatically charge the card in the future. If you owe a balance that you can’t pay off in full, consider moving the balance on the card you’re about to cancel over to a card you plan to keep with a balance transfer. And before you officially cancel the card, contact the card issuer directly to confirm the balance is zero.
8. Applying for too much credit too quickly
It can be tempting to apply for multiple new credit cards at once, especially when there are lucrative sign-up offers involved. Or reactively apply for a new credit card just moments after you got rejected for another.
However, applying for multiple new cards in a short period of time can have a negative impact on your score as it can raise red flags that you’re a risky borrower and desperately in need of new credit.
It’s always recommended you space out credit applications a few months apart. If you’ve had repeated instances of credit card rejections, you may want to consider secured credit cards – which have virtually guaranteed approval rates and can help rebuild your credit score when used responsibly by reporting your payment activity to credit bureaus.
9. Not knowing how “joint credit cards” really work
If you share a credit card account with someone else – like your partner or family member – you should know if and how it can impact your credit score.
First, it’s important to recognize that if you’ve been added as an authorized user on someone else’s credit card, the account will not appear on your credit report and won’t go towards building your credit score. As an authorized user, you only have permission to use the card to make purchases. That’s it.
If you’re the primary account holder and added someone as an authorized user, it’s also critical to know that you alone are responsible for the entire balance on the credit card – including those payments made by the authorized user. You and your credit score alone are on the hook for any potential missed or late payments, interest charges, or balances owed.
Finally, if you’ve co-signed on a credit card with someone else, your credit score will be directly impacted by their activities. Therefore, you’ll want to be extremely cautious about who you add as an authorized user or co-sign for since their card activity can have a profound impact on your credit score.
10. Overanalyzing your credit score
Although applying for a credit card or a loan will cause your score to go down, that’s what happens to everyone. One month it might be 850 and the next it’s 830. It’s nothing to worry about because a score that’s 760 or higher is still considered to be excellent.
But if you constantly check your score, you might become obsessed. It can also be confusing if your score bounces around from month to month for no reason, especially if you haven’t applied for any credit over that period of time.
If you do apply for more credit and see a drop in your score, it should bounce back as long as you use your new credit responsibly.