The Domino Effect: How Small Items Impact Credit

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Credit scoring is a complicated and diverse process, relying on mathematical equations used by the major bureaus — TransUnion, Experian and Equifax. The Five Factors of credit scoring provide consumers with a baseline, allowing us to see how payment history, debt utilization, credit length, new credit and diversification impact the process. While you may think big-ticket items like mortgages and auto loans determine your score, small items can affect credit just as significantly. Read on to learn some examples and best practices.

1. Late payments. Credit damage caused by late payments is unpredictable, so it’s best to keep your accounts positive. Consider the following example:

Kelley has an active credit account with a major U.S. bank. She paid her bill five days late last month, but her credit score was not damaged. Kelley’s friend Bryan has a credit card with a competing bank. Unlike Kelley, Bryan’s credit score dropped when he paid his bill six days late.

Reporting late payments lies in the hands of individual lenders. While most will not report a late payment before a 30-day delinquency, others will. According to FICO, this “small” mistake could cause a 90 to 110 point loss on a score of 780. Protect yourself by paying bills in full and on time.

2. Parking tickets and overdue library books. A No Parking zone and a borrowed copy of Pride and Prejudice don’t have much in common, but violating community rules can lead to the same consequences. An unpaid parking ticket can be sold to a collection agency and cause long-term damage on your credit report, impacting score health. Similarly, outstanding library fees are subject to collections in severe cases, a consequence that will damage your credit for up to seven years. Avoid costly errors by keeping your driving record and library card clean and up-to-date.

3. Financing a purchase. Depending on your current score, buying an item with credit can help or hurt you. Consider the following example:

 Marie wants to buy a $2,000 sofa, but she can’t afford to pay cash. She decides to open a department store card with a popular retailer. The card has a $5,000 spending limit and the retailer requires a credit check before approving Marie’s purchase. An inquiry is placed in her credit file, and her overall credit utilization ratio increases from 31 to 34 percent.

In Marie’s case, a hard inquiry and utilization increase had a negative impact on her score. Consider the alternatives if you are in a similar situation. Credit damage isn’t worth the risk.

4. Maxing out credit. As Marie learned, increased credit utilization is a no-no for score health. Overusing credit is considered risky according to potential lenders and the credit bureaus, a fact that could result in a drop in your credit score. Maintain balance by keeping your utilization ratio below 25 percent.

5. Inquiries. A hard inquiry allows a third-party lender to view your credit report before providing a service. Too many inquiries imply that you rely heavily on borrowed money, a perception that leads to credit damage. Actions that cause hard inquiries include:

  • Requesting a credit line increase
  • Securing pre-approval for a mortgage
  • Securing approval for an auto loan
  • Setting up new services, e.g., cable and utilities
  • Applying for an apartment rental
  • Opening department store cards or other lines of credit

Avoid damage by limiting the number of inquiries on your report in a 12 month period. If banks are competing for your business, i.e., in the case of mortgage approval, be sure all inquiries are made within the same 30 day period.

6. Closing an account. You may think closing an old or unused account is a wise choice, but think twice before taking this step. Closing an old account also means erasing years of positive credit use, shortening your history in the process. It also means a higher credit utilization ratio. For example, suppose you have three credit cards:

  • Card A: $2,500 balance, $5,000 limit
  • Card B: $0 balance, $6,000 limit
  • Card C: $500 balance, $3,000 limit

Total Debt: $3,000
Total Credit Limit: $14,000
Utilization Ratio (Debt/Limit): 21.4 percent

Closing Card B would reduce your credit limit to $8,000, effectively raising your utilization ratio to 37.5 percent. The higher the ratio, the higher the risk to your credit score.

The bottom line: When it comes to credit, even small infractions can carry large consequences. Weigh your actions carefully.