Common Credit Mistakes
An incomplete understanding of credit scoring can lead borrowers to make poor choices when attempting to boost their scores. Following are the top 10 mistakes consumers make when attempting to improve their credit scores.
Mistake #1: Paying off old collection accounts believing it will improve one’s score
After six months of inactivity, the impact of a derogatory statement lessens dramatically. Making a payment on an old collection makes that item active again and can actually impact a credit score negatively.
Solely in the interest of impacting a credit score positively—for instance, for the purpose of securing a mortgage—it is important to recognize that the greatest damage has already been done to the credit score through the initial nonpayment on that account. Making the account current again would have an additional negative impact on the score. Once the borrower has obtained the mortgage loan, the borrower can make the outstanding payment(s) on the account in order to build a better score for the future.
Mistake #2: Filing bankruptcy or using credit counseling as a means to improve credit
A bankruptcy stays on a person’s credit report for up to 10 years and has a great impact on the credit score. In a Chapter 13 bankruptcy, the consumer still must pay off the debt, creating potentially more derogatory statements in addition to the bankruptcy.
If a consumer has had credit counseling, it not only indicates that the consumer could not handle having credit, but it also shows that instead of paying what was owed, the person had someone negotiate a lesser amount to pay. Creditors do not like to think that they are not going to get the full amount owed to them.
Mistake #3: Applying for new credit to consolidate debt
Applying for new credit can negatively impact a consumer’s credit score in a number of ways.
First, every time the consumer applies for credit, points are deducted from the consumer’s credit score. Second, acquiring new credit indicates that the consumer may not be able to handle the debt the consumer already has. Third, newer accounts lower a person’s average account age, negatively impacting the credit score. And finally, when consolidating debt, the consumer runs the risk of taking on more than 20% of the consumer’s credit limit.
Mistake #4: Canceling old credit cards to increase credit score
The length of credit history impacts 15% of a consumer’s credit score, and canceling old credit cards would make a consumer’s credit history appear shorter, thereby decreasing the overall score.
Mistake #5: Taking out mortgage loans to pay off debts
While it is good to have a mix of different types of credit, it is not necessary to have every type. Having too many mortgage loans can make it appear as though the consumer is overextended.
Mistake #6: Shopping for credit to get the best interest rates
Every time a consumer authorizes a creditor to pull a credit report, the consumer loses points. The credit report will show all the times it was pulled, but it does not attach a note that says, “Sally declined the credit from this creditor because the interest rate wasn’t low enough.” It only shows that Sally was asking multiple creditors to extend credit to her.
Mistake #7: Not using credit cards at all in order to raise one’s credit score
If the consumer does not use a credit card for six months, it becomes inactive. Once it becomes inactive, it ceases to contribute to the consumer’s credit score. It is better to have an active credit card in good standing with a small balance.
Mistake #8: Using a small amount of credit and then paying it off before receiving a bill or paying it off in full at the end of the month to increase a credit score
If a consumer fails to carry a balance on a particular account, the creditor will not report the account to the credit bureaus. An account that is not reported is an account that is not helping the consumer’s credit score.
Mistake #9: Believing paying accounts on time will automatically fix a credit score
The greatest impact of late payments on a credit score happens during the first 30 to 60 days of being late. After that, the impact lessens. When a consumer makes a payment on such an account, it makes the account current and brings it to the “top of the list” again. Basically, the consumer has put a spotlight on the poor payment history, which is 35% of the credit score.
This is similar to Mistake #1. For example, assume that a 30-day late payment impacts a person’s score by 50 points. Then, a 60-day late payment deducts another 40 points. After that, those two late payments may only affect the score by 5 points because the newer a delinquency is, the greater its impact. Once the damage is done, consumers cannot go back and fix it. They should keep making their payments but must recognize that just making the payments on time will not erase the negative impact of previous late payments.
Mistake #10: Applying for new credit cards to increase a credit score
Having a credit report pulled when applying for new credit will, in fact, deduct points from a person’s credit score. In addition, securing new credit can also have a negative impact on a consumer’s score by lowering the average account age.
Essentials of Real Estate Finance Fifteenth EditionDoris Barrell, GRI, DREI