Worried about your credit score? These mistakes may be dragging you down

A good credit score can go a long way.

The rating, based on one’s ability to fulfill financial commitments, can be the driving force behind whether or not a lender will sign off on a loan or mortgage. A higher score can provide borrowers with lower interest rates and even open the door to new credit opportunities with better perks and cash-back options. A good credit score is not just about bragging rights: It shows responsibility to lenders and paves the way to financing your dreams.

Despite their importance, simple mistakes can mean the difference between a good score and a bad score. The way you balance your finances and manage payments plays an instrumental part in maintaining your rating, and these scores can often drop without you realizing the true cause.

Here are a few common mistakes many people make that can lead to a drop in credit score.

Late payments

Probably the most common explanation for a slip in ratings is people being late on paying back their loans. Whether it be for a mortgage or simply zeroing your monthly credit card balance, lenders expect to get their money back by the deadline set. Because over 30% of credit score is tied to payment history, accumulating overdue amounts can significantly deplete the overall number.

If creditors have not been paid for over a month, the loan might be reported to the credit bureaus and included on a credit report. If the borrower continues to postpone payment, companies may take more serious measures, such as hiring a debt collector or placing a “charge-off" on the account.

Charge-offs

Charge-offs occur when a delinquent account has evaded payment for so long that the creditor has decided to give up their pursuit. When they decide to charge off the account, a stain is left on the borrower's reputation as the user reported to the credit bureau. While this may sound like a creditor has given up and set the borrower free, the money owed is still expected, still accruing interest as it becomes dealt with by higher organizations. The remnants of a charge-off will remain on the borrower's account for seven years from the date of delinquency and will plummet one’s credit score, regardless of eventual repayment.

Only paying the monthly minimum

While it may seem like simply paying off your minimum monthly loan payment is the best option, the amount of interest compounded monthly will actually increase. If you can, pay beyond the baseline and it will likely lower your interest rates and improve your overall credit score.

Applying for a large amount of credit in a short period of time

When someone applies for a loan, it is customary the lender will perform what is called a “hard inquiry,” taking a deep dive into their credit report. Because hard inquiries affect your credit score, applying for multiple loans at once or in a short period of time will generate the reputation of a risky borrower.

If you are simply shopping for a lender rather than filing for multiple loans, you might still be subject to a hard inquiry from each individual firm. If the loans are attached to a mortgage or auto contract, as well as loans for new utility providers, the firms will likely file their individual hard inquiries under one examination. But for other loans, such as credit cards, you might face multiple hard inquiries, further hurting your credit score.

Closing out your credit card

Another factor involved in calculating a credit score is the “debt-to-credit ratio.” This determines how much credit you are currently using compared to what is available to you. Lenders prefer the number to reflect more credit than debt, ideally below 30%. Closing out on a credit card, along with opening up new accounts to try and mitigate debt, can impact your debt-to-credit ratio.

Closing a credit card can also disrupt the diversity of accounts in your credit report, as lenders like to see a wide variety of accounts held over a long period of time. Even if it is paid off, you will be better off keeping them open. But do not leave them around collecting cobwebs. If you do not use a credit card for a long period of time, lenders may reduce your line of credit or close it for you anyway.

Choosing the wrong card

While choosing a credit card without a credit limit is not inherently damaging, you may be tempted to overindulge with how much you spend. Eventually, you will have to pay off that money, which is why choosing a card with a credit limit, as well as manageable interest rates and fees will ensure that you will be able to pay everything off each month. That way, you will not be late on your payments or lower your score.

Defaulting on your loans

If you miss more than one payment and do not pay it off, your account will be marked as defaulted. Similar to a charge-off, lenders will contact the credit bureaus and factor this into your data. Defaulted loans paint the borrower as a high-risk individual who might not pay back loans. This makes it harder to be accepted by creditors.

Declaring bankruptcy

While it is hardly a surprise that bankruptcy will damage your credit score, the extent of the damage often can be underestimated. Declaring bankruptcy is a legal maneuver relieving borrowers of their debtors and giving them the ability to start anew. While bankruptcy may discharge outstanding payments, it can also take a large chunk out of your ratings, even reducing a respectable credit score of 780 by as much as 240 points.

Having no credit history

It may seem like the easiest way to pay off your credit card is to never actually apply for one at all, but, more often than not, you will eventually need the help of lenders in buying a home or car. This is why you need their trust. If you have never taken out a credit card or applied for a loan, creditors will not have any information to base their judgements on when you apply.

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To prove you are a reliable borrower, it is recommended that you start out a credit card, only purchasing small items that can be paid off on time. That way you will create a pattern of trust and experience while also learning how to stick to a payment schedule.

Maintaining a good credit score may seem intimidating, but with a proper understanding of the ways many borrowers fail and ways to combat them, you should be able to maintain the proper reputation needed to apply for loans. Most importantly, paying loans off on time will ensure that you and your financial plans are able to flourish.