7 Credit Score Traps You Should Avoid
Don’t let credit score pitfalls hurt your personal finances. Laura answer reader questions and covers 7 traps that could upset your credit if you’re not looking out for them.
Maintaining good credit scores is a fundamental part of a healthy financial life. Having no or poor credit means you could:
- Have trouble getting a loan or mortgage
- Pay more for insurance
- Get turned down to rent an apartment
- Be denied certain government benefits
- Miss out on job opportunities that require a credit check
For the unwary, there are many credit pitfalls that can hurt you. In this post I’ll answer reader questions and cover 7 credit traps that could upset your finances if you’re not looking out for them.
Free Resource: Credit Score Survival Kit—download Laura’s tutorial for strategies to build and maintain excellent credit for life!
7 Credit Score Traps You Should Avoid
Pay attention to the following situations so they don’t come between you and a great credit score.
Trap #1: Getting talked into a retail store credit card
A Money Girl Podcast listener named Rhianne says, “I was recently kind of tricked into getting a retail store credit card because the clerk never mentioned the word credit. I closed the account as soon as I got home, but am very stressed out about it. Will I still owe money on the account?”
Signing up for a retail card at check out is one of the most common credit traps. You know the drill. We’ve all heard the enticing question, “Would you like to save 20% on your purchases today?”
There are pros and cons to retail store cards to consider before you make a split-second decision that may not be in your best interest.
A couple of major advantages you typically get with a store card are rewards—such as discounts, coupons, cash back, special promotions, or free shipping—and the opportunity to build credit (when you use the card responsibly, of course). I have a retail credit card with a store where I shop frequently and it saves me a lot of money.
The disadvantages include having a new spending temptation to use all those rewards, low credit limits, high interest rates, and a ding to your credit for making a new application.
Hard credit inquiries stay on your credit report for up to 2 years, which means they can hurt your ability to qualify for other accounts you may want or cause you to pay higher interest rates for them.
Rhianne asked if her canceled store card would cost her more money. Once she pays off the balance, no more interest will be charged, and the account will be dead. But even though she closed the account, it will remain on her credit report for up to 10 years. Cancelling a credit card, even immediately after you get it, doesn’t make it disappear from your credit history.
See Also: Best Tips to Improve Your Credit Score
Cancelling a credit card, even immediately after you get it, doesn’t make it disappear from your credit history.
Trap #2: Keeping a credit card balance
Many people are confused about how a credit card can be a powerful tool to improve your personal finances. They mistakenly believe that you have to carry a balance from month-to-month and pay interest in order to build credit. Nothing could be further from the truth!
Paying your credit card bill in full every month builds credit the same way as paying just the minimum balance. You don’t get more credit for paying off your entire balance—but you do save a lot of interest.
I strongly recommend that you pay off your credit card bills in full every month so you get a double benefit: paying no interest and building credit. When you follow this rule, having a high interest rate on a card doesn’t even matter because you’ll never get stuck paying it.
Also see: 8 Credit Card FAQs and Tips to Build Credit
Trap #3: Having a high credit utilization ratio
Your credit utilization ratio is a major factor in your credit scores, but too few people understand it or use it strategically. The ratio is a simple formula that divides your outstanding balance on a revolving account, such as a credit card or a line of credit, by your credit limit on the account.
For example, if you owe $500 on a credit card with a $1,000 credit limit, you have a 50% ($500 / $1,000 = 0.50) credit utilization. Your ratio tells potential lenders and merchants how much credit you’re using.
The lower your ratio the better. Low utilization says you’re using credit responsibly. High utilization says you’re maxed out and could even be close to missing a payment.
A good rule of thumb is to never exceed 20% to 25% of your limit on any credit account—even if you pay off high balances every month. To learn more, read or listen to episode 270 called Credit Utilization—What It Means for Your Credit Score.
Trap #4: Being an authorized user on a delinquent account
A credit card authorized user is someone a card owner adds to his or her account. The user has permission to have a card and make charges, but isn’t responsible for any amount of debt on the account.
Becoming an authorized user is generally a great strategy for building credit because the card’s activity shows up on your credit report—as long as the card company reports it to the credit bureaus. However, being an authorized user can backfire and be a huge credit trap if the primary cardholder doesn’t make payments on time.
Anything negative that appears on your credit file—even if you don’t own the account—will hurt your credit if you don’t take quick action. So don’t allow a cardholder’s negative history to also drag down your credit.
To protect yourself, review your credit report on a regular basis. Watch out for red flags, such as late payments and high balances. You can contact the card company and ask to be removed as a user on the account.
Also dispute the user account with each of the credit bureaus that reports the negative information on your credit report. How it’s resolved will depend on state law and whether you’re married to the card owner.
See Also: Credit Card Authorized Users—How to Avoid Getting Burned.
A good rule of thumb is to never exceed 20% to 25% of your limit on any credit account—even if you pay off high balances every month.
Trap #5: Not paying medical bills
Medical bills are the most common kind of past due debt; they show up as bad marks on the credit reports of one in five U.S. adults. But many people mistakenly believe that past due medical bills don’t count against you or cause problems for your credit. That’s absolutely not true.
When a doctor, dentist, or hospital turns your account over to a collections agency, it hurts your credit just like any other collection account. However, recent regulatory changes require national credit bureaus to wait 180 days before adding past due medical debt to your credit report. That gives you more time to navigate the complex world of medical billing and health insurance.
In addition, FICO, one of the most well known credit scoring companies, introduced a new scoring model called FICO 9. This version gives less weight to unpaid medical collection accounts. Lenders don’t have to use it, but it’s a step in the right direction for consumers.
A podcast listener named Erica says, “I have health insurance through work and my domestic partner is covered under my policy. He had surgery in April, but is behind on paying for it. If the medical bills are in his name only, can it still affect my credit?”
Medical bills that are not in your name, won’t affect your credit, even if you share the same insurance. That’s because you owe money to the hospital or doctor, not the insurance company.
However, when you’re married and live in a community property state, both spouses are equally responsible for debt created during your marriage. I covered more about this topic in last week’s post, The Truth About Debt and Death.
Trap #6: Avoiding credit accounts
I received an iTunes podcast review that criticized my recommendation to use credit cards to build good credit. The reviewer said, “A recent episode suggested owning 2 credit cards. How is that good advice to live a richer life? Someone’s goal should not be to have a good credit score, it should be to not need a credit score.”
The show he or she is referring to is episode 408, called How Many Credit Cards Should You Have for Good Credit? In it I answer a question about why a card company could unexpectedly close your account, how it affects your credit, and how to use cards strategically.
No matter if you agree with the credit system in the U.S. or not, having poor credit is expensive and will affect your quality of life.
No matter if you agree with the credit system in the U.S. or not, having poor credit is expensive and will affect your quality of life. That’s why your goal should be to have a great credit score.
As I mentioned at the beginning of this post, your credit affects whether you can get a car loan or mortgage and how much it will cost. For instance, paying 5% instead of 4% for a $200,000, 30-year mortgage will cost you an extra $45,000 in interest.
A recent insuranceQuotes study found that having poor credit causes you to pay double for home insurance on average than when you have excellent credit. Even having median credit costs you an additional 32% nationwide.
They also studied the effect of credit on auto insurance and found similar results: poor credit causes your auto policy to rise 91% and median credit bumps your rate 24% on average.
I covered more about this topic in podcast 415, called The Truth About Credit and Insurance Rates.
Trap #7: Not having an emergency fund
I podcast listener named Thomesa says, “I enjoy your podcast and being a part of your Dominate Your Dollars Facebook group. My goal is to become a homeowner, but my credit is terrible due to a divorce. I had to stop paying my credit cards and they went into collections.
But I’m earning more money now and have paid off or settled all of the balances. I have several unsecured cards and one secured card that I pay off in full every month. What else can I do to improve my credit and how long will it take?”
Thomesa didn’t mention if she had a financial safety net or not prior to her divorce. Many times we fall into the trap of using credit cards as a substitute for emergency savings because we’re not prepared financially for a crisis.
It’s great to have credit as a fallback, but racking up interest is expensive and not keeping up with minimum payments can ruin your credit. I’m glad Thomesa cleaned up her debt and will have a better financial future.
How long it takes to bounce back from poor credit depends on many factors, such as whether you declared bankruptcy, how good your credit was to begin with, and if you make any additional late payments.
Accounts that go into collections remain on your credit history for 7 years. However, recent good credit behavior—such as making payments on time and keeping a low utilization ratio—begin to overshadow a negative history over time.
I can’t say exactly when Thomesa’s credit scores will trend up, but if she shows responsible behavior and payment patterns, she should see positive movement within 18 to 24 months.
To make sure your credit stays healthy, review your credit reports on a regular basis. user! You can get a free report every 12 months from each of the 3 nationwide credit bureaus (Experian, Equifax, and TransUnion) at annualcreditreport.com.
You can also get at least one of your credit reports and scores for free from the following sites:
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.
