The Biggest Credit Mistake People Make

PHOTO: Choosing the right credit card for your lifestyle can help you avoid credit mistakes.

Some credit mistakes are obvious. Everybody knows the big one: Failing to pay your bills on time. If you're looking to wreck your credit score, there's no faster way.

Some credit mistakes aren't so obvious. What's worse, the biggest secret credit mistake — the one most people don't even know they're making — actually happens when people are trying to turn their credit score around and be more financially responsible.

That mistake is closing credit card accounts. I know this might sound surprising to some, especially those who have labored for years to pay off big credit card balances. It's understandable. You just made the final payment, and it would feel so good to call the customer service department of your credit card company and say (to paraphrase Henny Youngman): "Take my credit card, please!"

You have to resist temptation here. My best advice: Put your hands on your head, and back away from the phone. The truth of the matter is that, depending on your financial situation, closing credit accounts could be the biggest mistake you never saw coming.

First, the implications could come further down the road, long after you've forgotten about that closed account. The good news is that good credit sticks around longer than bad credit. Delinquencies and bankruptcies will stain your credit history for seven years and 10 years respectively, but a credit card account with zero delinquencies stays on your report for a full 10 years after it's closed — and your credit score will benefit from that history during that time. Unfortunately, after 10 years, that closed account will drop off your credit report. And when it does, you'll lose all of the positive history associated with that account. And if your overall length of credit history declines when that account goes away for good, then your score will take a hit. Surprise! The various aspects of your credit profile are weighted differently. FICO and the major credit bureaus allocate about 15 percent of your credit score to the age of your credit history. So, it still matters — but not that much.

Now for more bad news. The second largest component of your credit score (weighted at a hefty 30 percent) is called the "credit utilization ratio." It's a fancy way of saying, "How much of your available credit do you actually use?" The general rule: The less, the better. Less is defined as around 10%.

Allow me to illustrate this point: Let's say you're an adult in your 20s; you were approved for your first credit card at age 18, got a couple more during the years you inhabited the ivory tower of whatever institution of higher learning you attended and racked up a hefty amount of debt; you then busted your butt to pay it off. Other than that, you have a car loan and you rent your apartment.

If the combined available credit of your three credit card accounts is $15,000 and you are running a $2,000 balance, your utilization ratio is about 13.3 percent. This doesn't negatively impact your score. Let's say, however, in your continuing effort to protect you from yourself, you opt to close two of them. Your available credit is reduced to $5,000 and running that same $2,000 balance puts your utilization rate at 40 percent. This would definitely hurt your score and also make it much more difficult to replace that credit in the future.

  • 1
  • |
  • 2
Join the Discussion
blog comments powered by Disqus
You Might Also Like...