What makes up my credit score?
FICO, the most widely used credit score in the US, does not divulge the exact details on how it prepares a credit report. However, it is widely believed that around 65% of the total credit score of an individual is based on two factors - payment history and total outstanding debt.
All of us have some sort of understanding on the fact that credit scores play an important role in determining whether or not we qualify for a loan. Due to the importance credit scores play in our financial management, it is extremely important to understand the factors affecting it. Although a lot of people might have told you incessantly about making your mortgage and credit card payments on time, there are other factors too that can hurt your credit score. Not paying your library fee on time, or forgetting to return that rented video, can have a negative impact on your credit score. In the following paragraphs, we will take a look at some more surprising factors that can hurt your credit score.
Closing a Credit Card
You might think of this as the ideal catch-22 situation. If you have been dealing with a credit card debt for a long time, and now finally, as a sound financial decision, you have decided to pay off the debt and close the card once and for all, you might inadvertently end up hurting your credit score. Most credit rating bureaus in the US look at the history of your line of credit, and the available credit, while preparing your credit reports. People with longer credit scores are looked at favorably by credit rating agencies. Therefore, closing a credit card might cause a dip in your credit score . Also, when you pay off the overdue amount, your credit utilization decreases, which is rated positively by credit bureaus. On the other hand, closing that credit card completely will rob you of the opportunity of increasing your credit score. In case you have multiple credit cards, closing a debt-free credit card decreases the total available credit and increases the total credit utilization, leading to a drop in the credit score. So, if you have done the right thing of paying off the debt on a credit card, instead of closing it down completely, you should keep the account open so that it doesn't hurt your credit score.
Late Payments on Library Fee/Video Rentals
What would your reaction be if you get to know that your home loan application was rejected because of a delinquency that you had on a library fee a couple of years ago. Chances are that you will not believe that such a trivial thing can bring matters to a head. Well, after the sub-prime crisis, there has been a surge in reporting delinquencies, and libraries and video rental companies are vehemently reporting even minor debts to collection agencies, who seem to have a good working relationship with credit reporting agencies. Even unpaid parking and speeding tickets can cause your credit score to take a plunge.
Lack of Diverse Loans
Seems that it is not only Uncle Sam who looks at diversity favorably; even the three major credit scoring bureaus factor diversity in loans while preparing your credit reports. So, if you are under the impression that you will have a better credit score because you have only a couple of credit cards, you are in for a reality check. Credit bureaus look at the capability of an individual to manage different types of credit positively. Credit card debt falls under the 'revolving credit' category, while home loans are classified as 'non-revolving credit'. Although the credit rating agencies haven't explicitly stated how they go about preparing a credit report, it is widely believed that there is some sort of hierarchy as far as loans are concerned. Home loans are considered to be at the highest pedestal, and a person who has a mix of home loans, student loans, and credit card loans, will have a higher score (provided he is making timely payments) than somebody with a uniform type of loan.
Hard Inquires By Departmental Stores/Car Rentals
Retail stores come up with fabulous offers to make you sign up with them for one of their departmental cards. If you shop frequently at a particular store, it actually is a wise decision to take out a membership card from them. However, departmental cards make a hard inquiry on your credit report, which lowers your credit score by a good 5 - 10 points. It also stays on your credit report for around two years. Also, a lot of people prefer paying for a car rental service with their debit card. However, car rental companies make a hard inquiry on your credit report while accepting debit card payments, which leads to a decline in your credit score by a few points.
Going Cash Only
Carrying out most transactions with cash can be a good idea to reduce your debts, but surprisingly, it can have a negative impact on your credit score. Credit rating agencies need data about how effectively you deal with debts and manage multiple loans. When you use cash, they don't get any substantial data to prepare your credit report. Over a period of time, dormancy can cause a dip in your credit score.
Shopping Around for Deals for More than 45 days
While looking around for credit card offers or home loans, a hard inquiry is made on to your account by banks and lenders. To protect the interests of consumers, all the hard inquires on a credit report are treated as a 'single inquiry' up to a period of 30 to 45 days. However, if you have been shopping around for a home loan for more than a couple of months now, multiple hard inquires will be reflected on your credit report, leading to a decline in your credit score.
Requesting for a Credit Limit Decrease
If you are doing well in managing your debts, you might as well want to decrease the credit limit on your credit cards to prevent those impulsive purchases. However, a decrease in credit limit will directly take a toll on your credit score, because your available credit limit will fall. As we mentioned before, credit rating agencies favor lower credit utilization ratios - a lower credit limit will increase the credit utilization ratio, leading to a decrease in your credit score.
Joint Accounts with Ex-Spouse
The first and foremost thing to remember is that divorce has no direct bearing on your credit score. Credit rating agencies do not take into account the marital status of a person while preparing a credit report. However, divorce does impact your credit score negatively in those cases where people are joint-holders of a credit card, or have co-signed for a home loan. What it means is that, if a couple had taken a credit card jointly when they were married, and after their separation, the court directed the husband to handle the credit card debt, any delinquency on the husband's part will reflect on the credit score of the ex-wife as well. Although it sounds unfair, the fact is that, a divorce decree is applicable on ex-spouses, and not on lenders, who may still consider both people to be equally responsible for paying the debt.
These were some surprising factors that can hurt your credit score. Awareness about these factors that play an important role in your credit score can go a long way in maintaining a good credit history, and pave the way for sound financial management.
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