Why Did Your Credit Score Go Down? Common Mistakes (cardratings.com)

5 Common Mistakes That Can Cripple Your Credit Score
July 29, 2010
By: Beverly Blair Harzog

Have you ever been surprised when your FICO score dropped? Most likely, it's because you made one of the five mistakes below. Most people aren't aware of the impact some of these actions have. And what's interesting is that it appears that the higher your FICO score, the greater the drop when you make a mistake.

#1: Closing an account
People often decide to close a credit card account for one of two reasons. One, they think they have too many cards and that closing one will increase their score. Two, their credit limit has been decreased and they decide the card is no longer useful to them. But whatever your reasons are, closing an account can lower your score."There's a misconception that having too much available credit lowers your score. FICO scores don't take this into consideration. But when you close an account, it can often raise your utilization rate and that can lower your score," says Barry Paperno, Consumer Operations Manager for myFICO.com.

Your utilization rate is the ratio of your credit card balances to your credit limits. For instance, let's say you have two cards and one has a zero balance and one has a $1,000 balance. If each card has a $2,000 limit, your total limit (across both cards) is $4,000. Your utilization rate is $1,000/$4,000 = .25, or 25%. Not fabulous, but not too bad.

Close the account with the zero balance and your utilization rate jumps to 50% ($1,000/$2,000). Obviously, the amount of the impact on your score will vary according to your individual circumstances, but since the utilization rate may account for almost 30% of your score, you're FICO score will probably take a negative hit.

#2: Maxing out your credit cards
Many consumers make the mistake of thinking that their credit limit is an invitation to spend until it's gone. Now that you understand utilization rate, you probably now understand why maxing out your cards is a problem. Let's look at our example from #1 again. If you max out your two cards, you'll have a $4,000 balance with a $4,000 limit. It's doesn't take a math genius to quickly figure out that your utilization rate is now 100%.

Your FICO score will take a hit. How much? "It depends on a lot of variables, including what your FICO score was before you maxed out your cards," says Paterno. myFICO.com recently did a comparison of how much a score drops when one individual has a FICO score of 680 and the other individual has a FICO score of 780. Maxing out credit cards was one the "missteps" they used in the comparison.

Results showed that the consumer with the 780 score experienced a 25-45 point drop and the score fell into the 735-755 range. The person with the 680 score saw only a 10-30 point drop and the score fell into the 650-670 range. You can check out the study here.


#3: Making late payments
One problem with making late payments is that, depending on the terms and conditions of your card, you might trigger the penalty APR. The other problem with a 30-day or more delinquency is that it can make your score drop like a rock. "Someone with a 780 score could experience a drop of 100 points or more with a 30-day delinquent payment. If your score is in the 680 range, expect to lose about 60-80 points," says Paterno. Now, if this late payment stretches into collections, then expect a really big drop.

#4: Impulsively opening accounts to save 15%
This happens every holiday season, doesn't it? Whether it's a Labor Day sale or Black Friday, you're standing in line in your favorite department store holding a lot of merchandise, and then the cashier tempts you with a "get 15% off if you open an account today" offer. When you open a new account, this results in a hard inquiry, which affects your score. But that's only part of the problem.

"Typically, inquiries knock only about five points off your score. The bigger problem is opening an account with a high interest rate and putting yourself in a situation where you get behind on a payment," says Paterno. If you're on the bubble between having good credit and excellent credit, those five points can mean a lot. And of course, if you end up with late payments, matters deteriorate from there.

#5: Not understanding the importance of the length of credit history
This mistake often ties into the #1 mistake on this list. Sometimes when people close a card, they close one they've had a long time. The length of your credit history makes up 15% of your FICO score. Now, FICO scores are calculated based on the average length of time you've had your credit cards. The score considers both your current accounts and any closed accounts still included on your credit report. Credit bureaus typically keep account histories on your credit report for years after you close the account or pay off the loan. "If you close a card you've had for ten years, this can eventually bring down the average length of your credit history," says Paterno.



About the Author
Beverly Blair Harzog is a spokeswoman and contributing editor for CardRatings.com. She's a former CPA and an award-winning personal finance journalist. She's a former columnist for the Navy Federal Credit Union’s magazine, Home Port, and has written about credit issues for CNNMoney.com, FoxBusiness.com, Good Housekeeping, Bankrate.com, Bottom Line Wealth, CreditCards.com, AARP Bulletin Today, and more. She’s also the co-author of The Complete Idiot's Guide to Person-to-Person Lending (Alpha Books/Penguin, April 2009). Follow her on Twitter @beverlyharzog .

CREDIT LAND MINES - FROM consumerinfo.com (Experian)

Possible land mines

Your sense of financial well being can be obliterated easily by any number of land mines that lie in wait for the unsavvy user of credit. Here are a few of them.

The cost of cash advances

Getting cash from your credit card is one of the most expensive ways to put money in your pocket. There is usually no grace period on cash advances. That means you're charged interest the second the ATM spits out the cash. And lenders often charge a higher interest rate for this "convenience." So on top of the fee you'll pay to get a cash advance - typically around 2% of the total - you'll pay a higher interest from the day you get it. With all of this in mind, you might want to reserve cash advances for true emergencies.

Short or non-existent grace periods

If you'll be paying your bill in full every month, you'll want a reasonable "grace period" in which to pay the bill before interest charges start accruing. Look at the disclosure information to see when interest is charged on new purchases, and make sure you pay your bill on time. If your payment is one day late it will almost certainly trigger interest charges. Also, if you carry a balance over months, chances are you'll have no grace period for new purchases.

When dealing with debt consolidation and finance companies, consider that you may end up with one monthly bill, but you might end up paying quite a bit of money for a long time for that convenience. If you use a home equity loan to consolidate, you are using your home as collateral.

Low minimum monthly payments

The minimum may only be 2% to 3% of the balance, a number that sounds low enough to some people. However, the price of any given item will be relatively steep over time and it may take years before you finally pay the bill in full.

Low APRs

If you'll be running a balance, the interest rate or APR annual percentage rate) will be an important consideration. Find a card with a low APR, but do keep in mind that the lowest APRs (around 2.9%) are "teaser rates." Teaser rates go up sharply as soon as the introductory period expires. Read the fine print to see when the rate will go up and the maximum rate that can be charged. If you're not prepared to pay your balance in full by the end of the teaser period, don't fall for the pitch. Instead, find a regular card with the lowest rate for which you qualify. Be sure to check with as many creditors as possible and shop around for the best rates.

Are you considering an advance-fee loans? These are almost always a bad deal. You pay a fee of hundreds of dollars for a company to guarantee you'll receive a credit card or personal loan. Legitimate creditors will not guarantee a loan and will not ask for payment until the consumer has received the loan.

Unauthorized use of a credit card

A dishonest person can use a consumer's name, card number and expiration date to order items over the phone, the Internet or through a catalogue. If a credit card has been lost or stolen, notify the card issuer immediately. Pre-approved card offers can be stolen from a mailbox without the knowledge of the intended recipient and redirected elsewhere. If not shredded, information containing credit card numbers and names can be taken from trash containers. In addition to fraudulent charges, identity theft - a much more severe problem - can result.

Credit report misinformation

Check your report at least once a year to make sure information is being reported correctly. While inaccuracies that affect your creditworthiness are rare, it can happen. Credit bureaus like Experian® can help you make sure everything is correct.

Mistakes on a credit card bill

Study your monthly bill carefully and compare the charges against sales receipts. If you have any doubts about a charge, call the credit card company and ask them to provide more information. Make sure the APR listed on the statement is correct, especially if you have a low APR as a promotional offer. Check to see if returned purchases were correctly credited to your account.

Impulse buying

With the power of plastic, it's certainly tempting to indulge in purchases you don't necessarily need. Such purchases can add up fast and generate a balance that takes you by surprise. When you're contemplating an impulse purchase on credit, take a second to think about the check you'll be writing to cover the cost a month down the road.

This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.