Few Surprising matters that may damage your Credit Scores
We all know that making late payments or having credit card accounts in collections can hurt your credit scores. But you might be shocked to learn that a lot of other seemingly innocent actions can also negatively impact your credit rating.
Here's a list of five surprising things that can lower your credit scores -- and keep you from having a stellar credit report.
Renting a Car with a Debit Card
I learned about this credit-busting issue the hard way: after I rented a car in 2009 from Avis using my debit card.
I thought I was being responsible by using a debit card linked to my checking account. After all, I figured, a debit card would help me avoid unnecessary credit card debt bills and stick to my zero debt lifestyle.
In the fine print of its rental agreements, Avis includes a clause that basically says the company has the right to pull your credit report if you use a debit card as opposed to a credit card. In all fairness, most other car rental companies have contracts with the same clause.
This makes absolutely no sense to me, especially since under the Fair Credit Reporting Act, companies that pull your credit rating are supposed to have a "permissible purpose" – as is the case when you're seeking a loan, credit or employment.
But renting a car doesn't fit into any of these categories. Obviously, car rental businesses see it differently. They want some extra protection for the privilege of "loaning" you a vehicle. If that's the case, instead of pulling credit reports, why don't they simply ask debit card users for upfront deposits, just as they do with those who pay by cash or credit card?
In any event, after I made the mistake of using my debit card to pay for my Avis car rental, the next day I received an email alert from my credit monitoring service. It notified me that there was an "inquiry" on my credit report from Avis and that my FICO credit score had dropped by 14 points. Needless to say, I've never used a debit card at a car rental company since.
Saying Yes to a Department Store Credit Card
When you're spending $50 or $100 at Macy's, Victoria's Secret or wherever you like to shop, I know it can be tempting to say yes to the nice lady behind the counter who offers you a 10% discount – if you just open an instant department store credit card. But believe me, you really should just say no.
Not only do department store cards carry much higher interest rates than do national brand cards, like Visa or MasterCard, but applying for that new store account definitely triggers a "hard inquiry" on your credit report because you're seeking credit.
The end result: You could wind up dinging your credit score.
Estimates are all over the place, but some experts say an inquiry can drop your credit score by 5 or so points, while others say a single inquiry could cost you up to 35 points, depending on your current credit standing. (Read more about how inquiries on your credit report impact your credit score).
Closing a Credit Card with a Zero Balance
For many people who've struggled with debt, when they finally manage to pay off a credit card, their natural tendency is to think "Good riddance." And many of those individuals will close a credit card balance once it's paid off.
But think twice about doing so – or else two quirks of the credit-scoring system could come back to haunt you.
The FICO scoring system operates based on a formula. FICO hasn't revealed all the ingredients in their secret sauce, but they have disclosed some guidelines.
About 30% of your FICO credit score is based on the amount of credit card debt you've charged. The lower the amount of credit card debt you're carrying, the better it is for your credit scores because you'll have a lower "credit utilization rate." For instance, let's say you have just one credit card. It has a $5,000 credit limit, and your balance is $4,000. Your credit utilization rate is 80% because you've charged 80% of your total credit line. Not good. Try to keep your credit utilization rate around 25% or less.
By closing an account, you could throw off your credit utilization rate, inadvertently lowering your credit scores. For example, let's assume you have two credit cards, each with a $5,000 limit. You've charged $1,000 on each card. So your total credit utilization rate is 20% ($2,000 divided by $10,000).
But now you decide to take advantage of a 0% balance transfer offer. So you transfer the full $1,000 balance from one card onto the other card offering you the 0% deal. Then you close the card with no balance. Suddenly, your credit profile has changed – and not for the better.
With just one card boasting a $5,000 limit and a current total balance of $2,000, your credit utilization rate has now jumped to 40% from 20%. Even though you haven't charged a single dime more, you appear "riskier" to the credit scoring system.
Another problem: 15% of your FICO score is determined by the length of your credit history. Older, more established accounts boost your credit rating. So closing an account – especially one you've had for a long time – could be detrimental to your credit health.
A closed account will still be included in your FICO score calculation. But after 10 years, closed accounts are dropped from your credit reports, so you won't get the benefit of that credit longevity when your FICO scores are tabulated down the road.
Buying Furniture from a Local Merchant and Using Their Financing
You might think that debt is debt. But all debt is not created equal – particularly when it comes to your credit scores.
Credit card debt, also known as "revolving debt," is scored less favorably than, say, a home loan. And lower-tier levels of debt, such as furniture store loans, are even further down on the credit totem pole.
So when you buy furniture from a mom-and-pop store, or even a big furniture retailer, and you finance it though that company, it can lower your credit rating because these firms are seen as lenders of last resort. Also, furniture store loans are typically reported to the credit bureaus as "revolving debt." Therefore, if you get a $1,000 credit limit from furniture store and you proceed to buy a $900 sofa and love seat, you'll appear to be nearly maxed out, which is bad for your credit score.
Remember, too, that FICO's credit scoring system grades the type of loans you have in your credit reports. The "mix" of credit you have accounts for 10% of your FICO scores. So having a healthy mix of credit – for instance a mortgage loan, an auto loan, a student loan and a credit card – is a good thing, as long as you pay all your bills on time. But stay away from furniture loans and household finance companies.
Having a Credit Card Company Not Report Your Credit Limits
All major credit card companies usually report your card balances and payment history to the "Big Three" credit reporting agencies – Equifax, Experian and TransUnion. But in some cases, credit card issuers don't report your credit card limits – or the maximum amount you could charge – to the credit bureaus.
When your credit limits aren't reported, as could be the case for consumers who have no-limit credit cards, your credit scores could suffer. The reason: Without an indication of your credit limit, most credit scoring models – including the FICO score and the Vantage Score – don't know how to properly calculate your credit utilization rate.
As I explain in my book, Perfect Credit, navigating the credit-scoring universe isn't always logical, fair or easy. Unfortunately, though, the system is what it is.
So it's up to consumers to know the written and unwritten rules about credit in order to survive and beat the complex, often frustrating, world of credit scores.
Sound off on this topic: Do you think the credit scoring system is fair? Why or why not?
