Sometimes your actions aimed to simplify your financial life can negatively influence your credit score. Can you imagine that moving a balance from a high APR credit card to an interest free plastic can lead to losing some important FICO points that lenders use to evaluate your creditworthiness? That seems unreasonable and even unfair! If you want to know more about the reasons that can make your FICO score go down, then this article is for you. We will tell you about three most common unexpected threats to your credit and the ways to fight back.
1. Cancelling credit cards.
Be aware of the fact that cancelling your plastics may lower your credit score. How much you owe makes up one third of your FICO score. Credit bureaus calculate the percentage between your credit card balances and your total amount of available credit. When you cancel a credit card, the amount of available credit reduces, but your debt remains the same. Thus the debt/available credit ratio (also called utilization ratio) will increase. You may seem to be close to maxing out your credit limits. That is not good for your credit score.
Moreover, 15% of your FICO score is determined by the length of your credit history. So credit card cancellation won't allow you to benefit from a long credit history.
Solution: Your utilization ratio should be 30% or lower. You can build up your credit score by paying your credit bills on time and reducing your debt.
2. Consolidating you credit card debts/Balance transfers.
Transferring your balance to a plastic with a lower limit or consolidating debts can hurt your FICO score. The reasons are the same as above: your debt/available credit ratio will increase. The credit-scoring formulas like to see a nice wide gap between your balances and your limits. Closing the old account reduces the amount of available credit. It may seem that you are close to being overextended, so the credit score can react negatively. In other words, the FICO formulas would typically prefer to see $1,000 balances on three cards than a $3,000 balance on one plastic.
Solution: Don't close the plastic from which you moved the balance until you have paid off your debt. Consider the lower rate as a chance to reduce your debt. Paying off your balance can be equally good for your wallet and for your credit score.
3. Using no pre-set limit credit card.
Having a credit card with no limit can be tricky. Despite its advantages, there is no credit limit to report. That's why most credit companies report your highest balance as a credit limit to calculate your utilization ratio. For example, if a cardholder has a $10,000 balance one month, that becomes his or her credit limit. As a result, the customers' debt/available credit ratio could be very high. Even if you have little debt, your utilization ratio can be up to 100%. That will not play into your hands.
Solution: Make a huge charge on your no pre-set limit credit card. Thus, if the credit company indeed reports the highest balance as a credit limit of your plastic, the charge will be considered as a high limit.
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