Written by John Ulzheimer
When you embark on the journey toward better credit, you will probably focus on the positive steps you can take. Paying your bills on time, lowering your credit card balances, and avoiding excessive credit applications are all ways to improve your scores. And while learning how to improve credit is always a smart move, it’s equally important for you to “first, do no harm.” Do this by becoming familiar with these seven “credit killers” that almost always lead to lower credit scores.
Credit Killer #1: Not Having an Emergency Fund
Most credit killers are pretty obvious because they have a direct line to your credit reports, like missing loan payments or filing bankruptcy. Others credit killers are less well-known, which makes them even more dangerous. Not having an emergency savings account is one of the lesser-known credit killers, one that can destroy your Just to be clear, a savings account has no direct effect on your credit scores because none of the account information appears on your credit reports. Since credit scores are based solely on the information found on your reports it’s impossible for a savings account or the lack thereof to influence your credit scores.
However, not having a rainy day fund can absolutely lead to a credit score disaster when financial difficulties arise. The reason that not having an emergency fund is so dangerous, even if you have a history of great credit management, is that it leaves you without any options if an unexpected expense or serious financial issue occurs.
For example, what will you do if you have unexpected car repairs or, even worse, you’re unable to work for a period of time due to an unanticipated illness? When you don’t have an emergency fund then you will almost always turn to credit cards when an emergency arises. When you overextends yourself and charge more than you can afford to pay off in a month, then your credit scores are going to take a hit.
Having large balances on your credit cards is expensive and indicates that you are a higher credit risk. This isn’t just a theory; the credit score developers at FICO and VantageScore have both included credit card debt as one of the most problematic attributes that can appear on a credit report. Consumers who have large amounts of credit card debt are ticking time bombs and not having a enough money set aside to make the minimum payments will lead to late payments and eventually defaults. Once you start that downward credit spiral, it can take years to build your scores back up.
Budget Isn’t a Dirty Word
The solution to this problem is very simple. Start by adjusting your budget (or draw up a budget if you aren’t using one already), and plan to save a certain amount each month to build up financial reserves.
But how much should you set aside for emergencies?
Most financial experts recommend having an emergency fund that is equal to at least six months of a your post-tax income. Therefore, if you bring home $4,000 per month after taxes you would want to stash away a minimum of $24,000 in your emergency fund account. Of course, you can’t save six month’s worth of income overnight, but you need to make a solid plan to get there sooner rather than later. It may sound cliché but the truth is that when it comes to saving money, failing to plan is about the same as planning to fail.
Start by trying to set aside $1,000. That amount can cover small expenses that pop up, and is a good step toward building a safety net of six months’ expenses.
Credit Killer #2: Bankruptcy
You shouldn’t be surprised to find bankruptcy on the list of credit killers you want to avoid. When you choose to file for bankruptcy protection from your creditors, the impact on your credit scores will be devastating and long-lasting. The temptation of walking away from overwhelming debt may sound appealing, but it is important to only use bankruptcy as the absolute last resort.
How Bankruptcy Impacts Credit Scores
Bankruptcies will have a negative impact on two different sections of your credit reports. First, it will show up in the public records section of your three credit reports. In addition to the public record, each debt that was included in the bankruptcy will be noted as such on your credit reports. Each account will be considered a serious derogatory.
How Long Bankruptcy Impacts Credit Scores
The Fair Credit Reporting Act (FCRA) is the law that governs how long bad stuff can remain on your credit reports. A Chapter 7 Bankruptcy, also known as liquidation, stay on your credit reports for 10 years from the date the bankruptcy was filed. A Chapter 13 Bankruptcy, also known as reorganization, has slightly more complicated credit-reporting rules than the Chapter 7. The credit reporting agencies must remove a Chapter 13 Bankruptcy from credit reports either 7 years from the date the bankruptcy was discharged or 10 years from the date the bankruptcy was filed – whichever comes first. Essentially both types of consumer bankruptcies can remain on your credit reports for up to a decade.
The Good News
Although bankruptcy does have the potential to cause severe credit damage, filing for bankruptcy does not automatically mean your credit scores will be a disaster for the next decade. There are steps you can take to start rebuilding.
- Secured Credit Cards
Establishing new, positive credit after filing for bankruptcy is a great step in the right direction. While many credit card issuers are hesitant to do business with a consumer who has filed for bankruptcy there are also quite a few secured credit card issuers who are more flexible. Secured credit cards are generally easier to qualify for, which makes them a quick way to get something good on your credit reports. Of course, it’s important for you to manage the new account properly in order for it to help your credit scores.
- Credit Builder Loans
Another great option for establishing new credit after a bankruptcy is the credit builder loan. Many credit unions offer this small dollar loan (generally $1,000 or less) to consumers as a way to begin building or rebuilding their credit. This might be a surprise, as you’ve probably never heard of a credit builder loan.
The funds from the loan are deposited into an interest bearing savings account, which the credit union will control until the you have paid the loan in full. You will make monthly payments to the credit union and, once the payments have been made in full, the funds and any interest earned will be released back to you. Plus, you’ll have the added bonus of around 12 months of solid payment history added to your credit reports (assuming you make the payments on time).
Credit Killer #3: Credit Card Debt
When credit cards are used improperly they can destroy your credit scores. However, it’s important for you to understand that credit cards themselves do not cause credit score damage. Instead, it’s the mismanagement of credit card accounts that can lead to problems.
As long as you are able to follow a smart and responsible usage strategy when it comes to credit cards then there is nothing to fear. Believing that credit cards cause credit and financial problems is the same as believing that pencils misspell words. Credit cards are simply a tool, and improper use is 100% voluntary.
What Is Responsible Credit Card Usage?
When it comes to using a credit card you have to focus on two things, and two things only. First you have to make your payments on time, every month, no exceptions. But maybe just as important as the on time payments are the balances on your cards. Your should aim to carry no balance from month to month, or if you can’t avoid that then you should try to have as low of a balance as possible.
If you open a credit card account, only use it for charges that keep you well under the credit limit, pay off the entire account balance every single month, then that credit card is virtually guaranteed to have help your credit scores. On the flip side, if you open a credit card account, make charges that approach the credit limit, or fail to pay off the balance in full each month, then the credit card is almost certainly going to hurt your credit scores.
Why Debt-to-Limit Problems Are Significant
Many people are surprised to learn that having large credit card balances actually damages their credit scores. In fact, even if you make every single payment on time your credit scores will still suffer if you still keep large balances. Credit scoring models like FICO and VantageScore measure the balances on your credit card cards relative to the credit limits. This metric is called revolving utilization or the debt-to-limit ratio. This makes up about one-third of your entire credit score, so it’s important to keep it under control.
Here’s how revolving utilization ratios are calculated:
If you have a credit card with a $10,000 limit and a balance of $7,500, then the account is 75% utilized. You simply divide the balance by the credit limit, which gives you the debt-to-limit ratio. This is calculated for each individual credit card, as well for all of your accounts combined.
How to Fix Debt-to-Limit Problems
- Pay Down Debt
Thankfully, it’s possible to regain any credit score points lost due to a high revolving utilization ratio by bringing down your balances. If you can afford to scale back your credit card usage and begin aggressively paying off the balances then you will begin to see an immediate credit score improvement. You don’t even have to pay down your credit cards to $0 before you’ll begin to see a boost in your credit score.
- Consolidate
Sometimes consumers find themselves in debt to the point that paying it down in a timely manner would be challenging or impossible. That doesn’t mean you’re without options. One strategy for dealing with credit card debt is to pay it off with an installment loan, also referred to as a personal loan
There are two benefits to paying off credit card debt with an installment loan. First, an installment loan is very likely to have a lower interest rate than your credit cards. Second, when revolving credit card debt is paid off with an installment loan, your credit scores are going to improve. Credit card debt is considered high risk, while installment loan debt is considered almost benign.
You should only use the installment loan strategy if you’re committed to changing how you use credit cards. You have to get to a point where you never charge more than you can afford to pay off in one month. If you pay off credit cards with an installment loan and turn around and charge up your credit cards again, then you’re setting yourself up for a credit catastrophe.
Credit Killer #4: Not Checking Your Credit Reports
One of the most common credit killers that is not properly monitoring your credit reports. The good news is that avoiding this credit killer easy if you make a habit of checking your credit reports and scores routinely.
Although consumers do have the right to expect accurate credit reports, mistakes can and do still occur. In fact, a study released by the Federal Trade Commission in 2013 found that 1 in 5 Americans has a mistake on at least 1 of their 3 credit reports.
Ultimately it is up to you to monitor your reports in order to ensure that they do, in fact, remain accurate. No one else will monitor a your credit reports for you. And, the credit bureaus aren’t going to provide you with copies of your reports or assistance getting them corrected unless you ask them to do so.
Free Annual Reports
Since 2003, thanks to Federal law, consumers have had a right to pull all three of their credit reports completely free of charge each year via AnnualCreditReport.com. Some states also give their residents the right to view their credit reports even more often as well.
For example, residents of Colorado, Georgia, Maine, Maryland, Massachusetts, New Jersey, and Vermont are entitled to additional free credit reports from each of the three major credit-reporting agencies.
While these free credit reports do not include credit scores, they are still a means of helping you get a feel for the quality of your credit reports. Shockingly, even though consumers have had the right to access their credit reports annually for over a decade, only a mere 4% of the available reports are claimed on a yearly basis.
The extremely low percentage is a clear indication that the majority of U.S. consumers do not keep a close enough eye on their credit reports.
Credit Killer #5: Late Payments
One of the most common credit killers is, without a doubt, the late payment. Surprisingly, this killer isn’t quite as straightforward as you may believe.
The Impact of Late Payments
Late payments, especially recent late payments, can be problematic when it comes to credit scores. The purpose of credit scores is to predict the likelihood that you will become 90 days late on any credit obligation within the next two years. If your credit reports demonstrate that you are likely to pay a credit obligation late, then your credit scores will most definitely suffer. You’re already doing what the model has been built to predict.
Roughly one-third of your credit score come from the payment history category. Any recent late payments, especially multiple late payments, can make it downright impossible for you to maintain good credit scores.
What to Do When a Late Payment Occurs
The best way to avoid late payments is to follow a well-planned budget and to make all payments on time. Having more bills than you can afford to pay is a recipe for financial and credit score disaster. However, sometimes an isolated late payment may occur due to a mistake, oversight, or other unusual event. When isolated late payments occur it’s sometimes possible to undo the damage if you can convince your creditor to grant you a goodwill removal of the late payment from your credit reports.
Goodwill Removal
Convincing a creditor to grant a goodwill removal of a late payment can be a bit of a long shot. You shouldn’t depend on it as part of your credit management strategy. However, if you have a great history of on-time payments with your creditors and an isolated late payment occurs then you may be able to talk them into essentially forgiving the late payment as a one-time courtesy.
To request a goodwill removal of a late payment you simply need to give your creditor a call. (Tip: it usually helps to request a supervisor as it may take someone a little higher up the corporate food chain to have the authority to approve the request.) Of course the creditor may refuse the request, but it doesn’t hurt to ask. If a goodwill removal is granted then you can expect your credit scores to immediately rebound as soon as the late payment is removed from your reports, assuming that no other negative credit report changes have occurred.
One more thing to keep in mind before asking for a goodwill removal is just how past due you became in the first place. Creditors are not allowed to report late payments to the credit bureaus until you are a full 30 days past the due date. That means if you do end up with a late payment on your credit reports you were, in fact, one full cycle past due. The point is, don’t try to argue with your creditors that you were almost on time because by the time a late payment ends up on your credit reports you were very late.
Credit Killer #6: Collection Accounts
When you miss payments for six months and go into default, it’s not uncommon for the lender to wash their hands of the item and hand it over to a 3rd party debt collector. These companies, often referred to as collection agencies, specialize in collecting debts from people who don’t want to pay them. They have wide latitude regarding not only the use of your credit report information for collection purposes, but they can also send this information to your credit reports for all to see.
There are many different types of collection accounts including medical, utility, credit cards, and broken leases, but all have one very important thing in common. Collection accounts of any kind are virtually guaranteed to be credit score killers. Smart consumers will want to protect their credit reports from collection accounts at all costs.
Credit Score Impact
When a collection account is placed on your credit reports the impact will be negative, perhaps extremely negative if your report was otherwise clean. To add insult to injury, a collection account will stay on there for 7 years from the date of default. Although the negative impact will lessen as time passes, any damage will continue to hurt your scores the entire time it’s on your reports.
Why Paying Collection Accounts May or May Not Solve the Problem
There are some collectors who are willing to avoid reporting the account to the credit bureaus as long as you are willing to make payments in short order. But if the collection does make its way to your credit reports then paying it will only result in the balance being updated to show a zero balance. The fact that the collection is paid will not undo the fact that the collection occurred in the first place and does nothing to help your credit scores, for now.
The newest versions of both the FICO scoring model (FICO 9) and the VantageScore scoring model (VantageScore 3.0) are programmed to ignore zero balance collection accounts. Because of this, you could actually see your credit score improve when you pays or settle it. The catch, however, is that these credit scoring models are not yet being used by most lenders, which means that it could be awhile before you are able to benefit from these changes.+
Solutions for Collection Accounts
Regardless of the credit score impact, you should pay or settle your collection accounts (assuming they’re accurate and you actually owe the debt). If you avoid paying the debt because of the lack of score improvement in older credit scoring models then you’re missing the forest for the trees. Ignoring debt collectors can leave you exposed and vulnerable to some nasty consequences including being sued by the debt collector, and you can’t ignore that.
The best strategy when dealing with collection agencies is answering the phone and working with them to find a mutually agreeable settlement amount. Ignoring them and sticking your head in the sand doesn’t work. They’ll almost always be willing to accept around 50% of what you actually owe as a settlement. And some of them will actually set up payment plans, despite the fact that you couldn’t or wouldn’t make payments under a similar deal with the original creditor.
Credit Killer #7: Serious Derogatory Items
To suggest that you should avoid judgments, tax liens, repossessions, and other serious derogatory credit killers might sound a little obvious. After all, most consumers never plan for these issues to occur in the first place. The truth is that with a well structured and well-followed budget you can avoid many of the credit killers that can creep into your credit reports.
Court Judgments
If a creditor sues you for an unpaid debt and the judge or jury rules in their favor, then a judgment is filed against you and a record of that judgment is placed in the court’s public records. Contrary to popular belief, the courthouse will not report the judgment to the credit reporting agencies. The reason judgments appear on credit reports is that the credit reporting agencies collect this information themselves through public record vendors such as LexisNexis.
The Fair Credit Reporting Act (FCRA) allows judgments to remain on a your credit reports for 7 years from the date the judgment is filed, and any negative impact is going to be felt for the entire period of time. And even if the 7 year limitation is being approached it’s not inconceivable that the judgment be renewed, which could lead to a new filing date and 7 more years of credit reporting.
Income Tax Liens
Tax liens are another credit killer you should do everything in your power to avoid, for more than just credit reporting reasons. When you fail to pay your tax obligation then the government may file a lien against your assets. A lien is the government’s way of protecting its right to claim your property when you fail to pay your taxes.
Like judgments, tax liens are also filed as public records meaning that anyone, including the credit reporting agencies, can see a tax lien once it has been filed. The credit reporting agencies will use public record vendors to pick up tax lien filings and attach them to your credit reports. Once a lien has been added it’s pretty safe to assume that the lien is going to have a negative impact on your credit scores.
Unpaid tax liens (both federal and state) do not have an expiration date when it comes to credit reporting. In other words, an unpaid tax lien is permitted to remain on your credit reports indefinitely if the credit bureaus choose to leave it there. Thankfully tax liens that have been paid or settled and released are removed from your credit reports 7 years from the date of release. Additionally, under the IRS Fresh Start Program, if you have paid your federal tax lien in full or entered into a payment agreement to do so then you may be eligible to request for the lien be withdrawn. If the request is granted then you can send proof of the withdrawal to the credit reporting agencies and have the lien removed from your credit reports.
Foreclosures
When a homeowner fails to make his mortgage payments the lender may seize the property, evict the homeowner, and sell the home to someone else. This process is known as foreclosure. Unsurprisingly, foreclosure is another credit killer that will almost always lower your credit scores. Foreclosures are allowed to remain on your credit reports for up to 7 years although they are reported by the mortgage lender despite being a public record.
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