Your credit score... is it just a nominal number not worth worrying about, or is it quite a significant number you should take a vested interest in?
For many Australians, the credit rating system is not something they take seriously, but did you know that this little number can have a significant and direct bearing on your life.
Would you like to buy a new car and use a loan to finance it? Your credit score will determine whether you can get it or not.
Would you like to buy a new home or refinance your existing home loan? The bank will check your credit score to make sure you can pay it off.
These are only two of the many scenarios in which your credit score can affect your quality of life in a very real way. So it pays to acquaint yourself with how this score can be damaged!
1. Applying for lots of credit cards
Want to send a signal to the banks that you're a potentially high risk customer not worthy of approving for a new credit card? Then start to apply for lots of new credit card accounts in quick succession.
Every time you apply for a new card the lender will perform an 'enquiry', which is a check of your credit file. These enquiries are stored so that other lenders can see if you've been busy trying to open other accounts. To the bank, a person who has been looking to open many other credit accounts is a bigger risk. And they would be correct - statistically you are more likely to get into trouble if you've been looking to open multiple credit lines in short order. Therefore the system is skewed to reward people with fewer enquiries with a higher credit score. So before you apply for another card or are being tempted to open a new store card to get an extra 10% off at the checkout, consider its impact on your credit rating.
How to avoid damage: Resist the urge to apply for more than one credit card inside a short period of time, especially if you have recently been declined.
2. Late payments
It's well known that missing a payment on your account isn't going to help your credit score. Banks will look at your file to see if you have been late on payments in the past because someone who hasn't been able to pay on time previously is more likely to miss payments in the future too. While you should take any missed payment seriously, the very occasional late payment is not something to lose sleep about.
However, missing payments on a regular basis will definitely hurt your credit score. If your payment is late by several months, then your score will be damaged much more than if you realise that you haven't paid after a couple of weeks and then bring everything up to date - forgetting to make a payment can happen to the best and most organised of us.
Another factor is when your last late payment happened. If you last missed a payment on account 5 years ago, then your score will reflect your more proven track record for reliability. However, if you've had several missed payments in the last 1 - 2 years, your score will take a hit.
How to avoid: Get your payments up to date as quickly as possible. Set up an automatic bill payment so that you won't miss a payment again.
3. Cancel your cards
It seems counterintuitive, but cancelling your credit cards is a fast track to a lower credit score. When you close an account, your rating also loses all the history that goes with it. If you're an average consumer who spends regularly with their card and pays it off each month, or even just makes the minimum payment on time, then your history is one of reliability.
So why would you want to have all that positive data removed from your history? It would be better to keep your account alive and use it every now and then to pay for a small item and pay it off in full at the end of the month in order to maintain your good credit rating.
Closing your unused credit cards will also change your credit utilisation score, a measurement of how much of the credit available you are currently using. Say you have two credit cards. One card has a credit limit of $10,000 and a balance of $5,000. If that was all the available credit you had then your utilisation would be 50%. If you had a second card, again with a credit limit of $10,000 but no balance, then your overall utilisation of credit is even less at 25% ($20,000 divided by $5,000). To the bank, it looks like you're in a healthy position. If you then removed your second unused credit card, your credit utilisation increases overnight from 25% to 50%, which is not a good sign and subsequently can result in your rating being decreased also.
How to avoid: Keep your unused cards open and spend lightly on them every now and then, paying them off in full as you do.
4. Maxing out your credit limit
Another common problem is when you keep spending on your credit card but only make the minimum monthly repayments. Over time this can lead to you maxing out your credit limit, which invariably leads to your score dropping.
If you have a credit limit of $10,000 and you've racked up a $9,000 balance, then you've used up 90% of your available credit. This is a sign to the banks that all is not well and that you could be a problem customer. Therefore, it’s best to keep your ratio of balance: available credit as low as you can.
How to avoid: Ideally you should pay off your balance in full at the end of each month. Not only will this mean you avoid over utilising your available credit, but it also means you won't be paying an expensive rate of interest on your outstanding debt. If paying off your credit card in full isn't possible, then look to reduce your spending and starting to pay back what you owe.
Maxed out your credit card? More tips on how to manage this are available here.
5. Non existent credit history
If you want a credit score, good or bad, then you need to establish a credit history. It's as simple as that!
Would you lend $10,000 to someone you didn't know? Of course not. Neither will the banks.
How to avoid: You can start small by taking out a mobile phone contract and paying it off monthly or perhaps taking a small amount of finance on a new computer. You could also apply for a credit card, providing you meet, or ideally exceed, all of their requirements. If you are establishing your credit history and have been approved for credit, make sure you stay up to date with your payments. We also have some tips if you've tried to build your score from scratch and run into trouble.