The way you use credit can have a positive or negative impact on your credit (or FICO®) score, the three-digit number issued by the major credit reporting agencies.
Each time you apply for credit, an inquiry is reported. Inquiries come in two forms: hard and soft. Both types of credit inquiries enable a third party, such as you or a lender, to view your credit report.
- Soft inquiries generally occur when someone checks your credit report as part of a background check, for a pre-approved credit card offer and when you check your own credit score. A soft inquiry doesn’t require your permission or affect your credit score.
- Hard inquiries occur when a lender or credit card issuer checks your credit to determine whether to give you a loan or credit. Hard inquiries happen when you apply for a loan, such as a credit card, auto loan, student loan or mortgage. Sometimes they occur when you apply to rent an apartment or car, sign up for a cable, phone, or Internet account, open accounts at a financial institution, or request a credit limit increase. Only a hard inquiry can negatively affect your credit score. They can remain on your report for two years.
Minimize hard inquiries as much as possible because your credit score may be penalized for multiple hard inquiries. Applying for too much credit at one time may indicate that you’re desperate for credit or
that you aren't able to qualify for credit. While one hard inquiry will usually just knock a few points off your credit score, multiple hard inquiries in a short amount of time may damage your score.
Applying for too much credit at one time may indicate that you’re desperate for credit or that you aren't able to qualify for credit.
Regardless of how long you’ve had good credit, missed payments put a black mark on your report.
On the other hand, a good balance of credit with consistent and timely payments can boost your score and keep it healthy.
Five factors determine your credit score: payment history, amount you owe, length of credit history, new credit and forms of credit.
The importance of these varies, depending on the length of your credit history and your overall credit profile. In addition, as information in your report changes, so does the importance of individual factors. Here is a deeper look at each:
- Payment history. Although this is only one piece of your credit picture, it’s one of the most important. However, a good overall credit picture can outweigh one or two late payments.
- Amounts owed. Owing money isn’t an automatic blot on your credit score. In fact, a healthy balance and timely payments can actually improve your credit score. However, if you’re using a high percentage of your available credit (which is called your credit utilization ratio or balance-to-limit ratio), it can indicate you’re overextended and a potential risk. Aim to keep your balances across all accounts below 30 percent of your available credit.
- Length of credit history. A longer credit history generally will increase your scores, depending on how the rest of the credit report looks. Accounts paid as agreed remain on file for up to 10 years from the date of last activity.
- New credit. Opening numerous accounts at one time can be detrimental to your score, especially if your credit history is short. That is because new accounts will lower your average account age.
- Types of credit in use. Generally, your credit mix is more important if your credit report doesn’t have a lot of other information on which to base your score.
Keep in mind that many lenders look at other factors in addition to your credit score when deciding whether to extend credit (and at what interest rate), such as how long you’ve worked for your employer and the type of credit you’re requesting.
Lowering Credit Utilization
Although credit is easy to use, you may hurt your score if you use a high percentage of the credit available to you. Here is how to keep your utilization rate low:
Use your credit cards wisely. Don’t use them to purchase more than you can pay off each month. Instead, set aside money each month to use for these purchases to pay your bill in full. For larger, more expensive purchases, save in advance so you can pay off the balance right away, thus avoiding high interest rates.
Control spending. It’s easy to spend $20 here and $40 there without thinking too much about it, which is how trouble starts. Keep track of your spending by reviewing your payment history online (or saving receipts if you’re old school) for one or two months to see where you can cut back.
Pay more than just the minimum. If you have credit card debt, paying just the minimum may cost you additional money. Paying the minimum may cover the interest only, which may be high for credit cards. You could spend years and thousands more than is necessary to pay it off, so increasing your payments may allow you to get rid of this debt faster.
Get help if you need it. If you’ve gotten in over your head, get reputable debt counseling to regain control and then use credit responsibly.
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