Most of us cannot cut a check to buy a house or a car. Instead, we rely on financing. A healthy credit score is often the golden ticket to getting a loan, but many people face credit challenges. In fact, nearly 56 percent of consumers have subprime credit scores, according to the CFED 2015 Assets and Opportunity Scorecard.
Different factors determine your credit score, and it probably comes as no shock that late payments are a credit-score killer. But payment history alone does not make or break your score. Other factors also play a key role in credit scoring.
So while it is absolutely necessary to pay all bills, you also need to practice other smart credit habits. Otherwise, you might end up hurting your score without realizing it.
Here are seven surprising ways you are bringing down your credit score.
1. Keeping a High Balance on Your Credit Cards
You might confidently think your timely payments are enough to maintain the highest credit score. But it does not work this way. While it is true that your payment record makes up a big chunk of your credit score — 35 percent, according to myFICO — credit scoring models also take into account the amount you owe.
In fact, the amount of debt you owe makes up 30 percent of your credit score — nearly as much as your payment record. So even if you pay bills on time, having a maxed out account or keeping credit card balances close to the limit can drag down your score
As a rule of thumb, credit scoring agencies such as Experian urge you to utilize no more than 30 percent of your available credit. The rule applies both to each individual card, and to all your credit cards as a group. So, if you have a credit card with a $1,000 limit, this card’s balance should never exceed $300. Likewise, if you have a total of five credit cards with a total credit limit of $5,000, your combined balances should never exceed $1,500.
Paying off balances can fix your credit score. If you cannot pay off balances, take the advice of J.R. Duren, a personal finance writer at HighYa.com, which provides product and services reviews and consumer education. Duren recommended moving balances around to achieve a lower utilization ratio. For example, he recently moved part of a balance from one card to another so that both cards would be under 30 percent utilization.
“My score went up about 20 points,” Duren said. “This is a really good thing to know when you’re planning to buy a home or a car, since a difference of 20 points in your score can get you a better interest rate and save thousands of dollars over the life of your loan.”
2. Leaving Some Credit Accounts Inactive
A credit card can build up your credit history and score, but only if you keep the account active. You might pay off a credit card and vow never to use the card again. However, doing so can unknowingly hurt your personal score.
Creditors monitor account activity, and your credit card company might shut down your account if there is inactivity. Having an account closed reduces your amount of available credit, which can cause a spike in your total utilization ratio. To make matter worse, credit scoring models might not include inactive accounts when calculating credit scores.
Many people — especially millennials — do not realize how important it is to demonstrate at least some credit activity in the six months prior to seeking a loan or anything else that is dependent on a good credit score, said Liran Amrany, co-founder and CEO of Debitize, a tool that helps you stay on top of your credit cards and pays your bill automatically.
“If you have no loans outstanding, and you never use your credit card — or don’t have one — you run the risk of becoming ‘unscorable,’ which means you probably will not get approved for whatever loan or apartment rental you might be seeking,” he said
It is OK to prefer cash over credit for a lot of your purchases. However, you should dust off your credit cards every couple of months, and make a small purchase to keep your accounts active.
3. Using Lenders Who Do Not Report Credit Activity
To build a stronger credit history, you need creditors to report positive activity to the credit bureaus. The more positive activity on your personal file, the higher your credit score. However, never simply assume that a particular bank or creditor automatically will report your activity.
Some creditors send updates to the bureaus on a daily or monthly basis, whereas others do not report to any of the bureaus. If your creditor does not update your credit reports, your credit score might never improve despite years of timely payments and responsible use.
Always inquire about reporting activity before applying for a bank loan or credit card. Find out which bureaus the bank reports to — and how often. If the bank does not report activity, consider looking for a different lender.
4. Relying on Authorized User Accounts to Build Your Score
Being added as an authorized user on someone’s credit account can benefit your credit score. Although you are not the primary account user, this account appears on your credit report, which can help establish your credit.
However, becoming an authorized user on someone else’s account gives that person power over your credit. The primary account user receives the monthly statement and is responsible for paying the bill — not you.
Your credit score benefits only if the primary user manages the account well by keeping a low balance and paying statements on time. If this individual defaults or if the card’s utilization ratio becomes greater than 30 percent, your credit score suffers the consequences.
Rather than piggyback off someone’s credit, ask to be removed as an authorized user. Then, build credit on your own. If you cannot qualify for an unsecured credit card due to bad credit or a lack of credit history, talk to your bank about getting a secured credit card. These cards require a security deposit, but can be a great option if you have bad credit or no credit.
5. Failing to Pay Tax Liabilities
An unpaid tax debt can end up on your credit report and hurt your credit score. Whether it is federal, state or city taxes, failure to pay can result in a tax lien, where the government places a legal claim on your property or assets.
A lien also appears as a public record on your credit report. Such a notation is a serious blemish. Unpaid tax liens can remain on your credit report for up to 10 years, and a paid tax lien can tarnish your credit file for up to seven years.
Always find a way to pay your tax bill. If you cannot pay what you owe in full, set up a payment plan to keep the tax debt off your credit report.
6. Agreeing to a Debt Settlement
Some creditors are open to negotiating a debt settlement, which lets you settle the debt for less than you owe. But while a debt settlement can reduce your financial obligation and help you get rid of a debt sooner, it can also have a negative impact on your credit score. That is because you do not fulfill the original agreement between you and the lender.
However, the potential for negative consequences depends on how your creditor reports the activity to the bureaus. Some creditors report settled accounts as “paid,” in which case your credit score does not suffer. But if the creditor reports the debt as “settled” or “not paid in full,” your score takes a hit.
Before agreeing to any type of settlement, inquire as to how a creditor will report the account. That way, there will be no surprises. You can request that your creditor report the debt as “paid.” The creditor is under no obligation to comply, but it is worth a shot.
7. Not Creating an Emergency Fund
An emergency fund is your backup plan when you need cash for life’s curveballs, such as a job loss, an illness or unexpected medical bills. If you do not have such a cash reserve, using a credit card might be the only option when an unexpected expense blindsides you.
“Many consumers live check to check with no savings and borrow money to fund their lifestyle. All goes well until something upsets the apple cart,” said Kevin Haney, owner of A.S.K. Benefit Solutions, a health insurance agency that publishes two financial literacy websites, Credit Bureau Insider and Growing Family Benefits.
He added that some people see their expenses suddenly rise. In other cases, income might suddenly fall. Regardless of the specific circumstances, the outcome is the same.
“They fall behind on payments, and the negative history, ruins their credit score for seven years,” Haney said.
Using a credit card for an emergency is not the worst decision you can make. But you can run into problems if an emergency maxes out your credit card, or if you are unable to afford higher minimum payments.
To rely less on credit, develop a savings strategy and commit to paying yourself first. If you cannot set aside 10 percent of your income, start with a smaller percentage and gradually increase contributions as your income allows.
Your credit matters, whether you are buying a house or a car, or purchasing insurance. And unfortunately, a bad credit score makes it harder to get financing. It can also cost you thousands of dollars in additional interest costs.
Fortunately, by recognizing the factors hurting your score, you are in a position to make better choices.