Part 2 in a Credit Score series
As a mortgage broker I see the mistakes people make that hurt their credit score. Some mistakes are just dumb, like not paying at least the minimum every month on credit cards. But others aren’t so obvious.
Considering a good credit score can save you tens of thousands of dollars over the life of your mortgage, these are all mistakes worth avoiding!
The five factors in the chart go into your credit score calculation. I’ll explain what each one means and show how you can maximize your scoring by learning from other people’s mistakes.
Factor 1: Payment History
Equifax tracks all your credit accounts and evaluates how current your debts are and how promptly you have paid your outstanding debts in the past. If you’re past due on any accounts now, or have been past due before, Equifax considers the amount outstanding and how long it took you to pay.
In addition, Equifax looks at any current active public records that indicate delinquencies, such as:
|Beacon Score: The credit score Equifax calculates based on the five credit factors|
|Credit accounts: Credit cards, lines of credit, personal loans, student loans, auto leases — short-term debt, also called “trade lines” or “credit lines“|
|Derogatories: Anything on your credit bureau that will decrease your credit score, such as a late payment on a credit card or a past debt going to collections|
• Current or past bankruptcy — any time you declared bankruptcy in the last seven years
• Current and past judgments — any current or past legal action against you from a loan going into default (e.g., traffic violation)
• Current and past collection items — any outstanding balances you may owe that have gone to a collection agency
• Current and past consumer proposals — a formal type of debt settlement agreement that stops creditors from taking legal action against you. This type of settlement still requires you to settle a portion of the debt. The advantage is that you have a lower payment and a smaller balance to pay out, and you avoid declaring bankruptcy.
Again, Equifax looks at the severity of the public record by both the amount and how long the delinquency has been past due.
What you can do about this? Avoid these credit mistakes.
Mistake: Not making the minimum payment
If you are not able to pay out some debts (e.g., credit cards) pay the minimum so you won’t be dinged with a late payment. When debt piles up there’s a natural tendency to give up and stop making payments with the thought that they can be paid in full later. Don’t do this! Make at least the minimum payment on your credit card if you can’t afford to pay it all out.
Mistake: Not staying on top of charges on a seldom-used credit card
The most common late payments I see are for a credit card that is seldom used, like a retail card (Bay, Sears, etc.). A client uses the card to take advantage of a promotion and then forgets about it until it’s too late.
Mistake: Not checking account balances regularly
Identity theft is rampant, and you never know when your credit card gets compromised. A client of mine discovered that he owed about $30,000 more on his MasterCard that he realized. He didn’t normally use that card and only realized about the balance when I asked him about it after taking his loan application! The balance was already several months old and he went through a long process to get it resolved. So check your credit card balances regularly even for credit cards you don’t usually use.
Mistake: Forgetting about credit card balances when going away or changing addresses
When you are about to go away for some time or move to a different address, make absolutely sure that all your current debts have been cleared. I am always surprised by how often I see derogatories in people’s credit reports because they simply forgot to pay their credit balance before departing, or they moved and forgot to inform the credit card company.
Factor 2: Amounts Owed
This pertains to how much money is owing on your current credit accounts. Equifax considers how much you owe with respect to how much your limit is and how many active credit accounts you have.
Mistake: Having all of your debt maxed out on one credit account
Equifax actually lowers your score if you are at or close to your credit limit. If you have all your debt maxing out a particular account, such as a card or line of credit, consider spreading out the loan over two or more credit lines. For example, if you have $20,000 owing on a credit card with a limit of $21,000, your credit score will likely get hit harder than if you had $10,000 owing on two separate credit cards, each with a $20,000 limit.
Mistake: Sticking with only one credit card
To build credit, have a few active credit accounts (credit cards, lines of credit, etc.) going at the same time. There are at least two good reasons for this:
• Multiple accounts supply more data and history for your credit score to build on.
• Multiple accounts can help hedge your score in case you miss a payment on one of them. For example if you were accidentally late in paying your Visa one month, your history on other credit cards/trade lines tells lenders that your late payment was an isolated mistake.
Factor 3: Length of Credit History
Equifax looks at how long you have had credit. The longer you have clean credit, the stronger your credit bureau and score looks. The quality of the credit you have counts with Equifax as well.
Mistake: Cancelling major credit cards after getting a new one
If you have only a couple of credit lines for a very short time, you can sometimes hurt your ability to obtain a mortgage by cancelling a credit card before establishing credit history on a new one.
It’s a common mistake for people who have short credit history to cancel their original credit card after they either get a new credit card or decide that they don’t need the credit card anymore. While that would seem like the responsible thing to do, lenders and Equifax don’t like it. Generally, they would like to see two years or more of credit history. If you’re just starting out with credit, I strongly suggest you keep your credit cards until you have established your credit for a few years.
Mistake: Not using your credit
If you are looking to build (or rebuild) your credit, get a few credit accounts and remember to use them. By using your credit, you begin to “activate” that account. I often suggest to my clients to just use it once or month or so for even the smallest purchases, like paying for a meal, groceries or gas.
Factor 4: Type of History
Equifax looks at the mix of credit you have and considers both the number of accounts and the quality of the credit.
Mistake: Focusing your credit on one credit type
A mix of different types of credit that includes credit cards, auto loans and lines of credit is more positive than a concentration of debt from credit cards only. You should always have one or two open major credit cards combined with another credit line like a personal loan or auto lease.
Factor 5: Inquiries
Equifax accounts for the number of recent hard credit inquiries made on an individual’s account.
Mistake: Running your credit many times over a short period of time
A few credit inquiries shouldn’t materially affect your score (unless your score is dangerously at or below a borderline score) so don’t worry about having your credit checked from time to time. Do try to avoid having your credit checked unnecessarily multiple times over a short period of time. Usually, this happens when you shop for a new vehicle or apply for several credit cards around the same time.
Your credit score is the first thing a lender looks at when deciding whether or not you deserve the best mortgage rate. If you avoid these common mistakes, you will.