Let’s be honest establishing and maintaining good credit is not always easy. Life happens and things go wrong. Financial literacy is at the heart of most of the problems. It contributes to being irresponsible and careless with our spending. Not fully understanding that the spending spree today must be paid for in the future. Sometimes within most of your future. Having a full understanding of how personal finances work goes a long way. However, no one can predict an unexpected illness, job loss, or emergency. Therefore, understanding what hurts your credit score the most is key to financial freedom.
What Hurts Your Credit Score the Most – The Usual Suspects
Some things you do may stop your credit score from increasing. They are the usual suspects. These things are what hurts your credit score the most – Late payments, monthly balances, maxing out your credit, bankruptcy, and foreclosure. Let’s take a look at each one of them.
Late or Missed Payments
Any payments that are 30+ days overdue will substantially reduce your credit score. Payment history makes up 35% of your credit score. I cannot stress how important it is to make at least the minimum payment on time to maintain a good credit score. Many creditors will waive any fees if this is your first late or missed payment within a given amount of time. You simply must call and ask them if they would remove the late fee. Most will certainly not report it to any of the credit bureaus. However, being habitually late and missing payments will result in a derogatory remark on your credit report.
Make every effort to pay your bills on time. Learning to Live below your means is key to financial independence. Read Living Below Your Means for additional information.
Not paying off your balances monthly – Utilization is a key issue and counts for 30% of your credit score. Hence, making this the 2nd most important after payment history. As a rule, you should keep this below 10%. For example, if your credit limit is $1,000 and you charge $100. Then your utilization is 10%. Charging $300, but your utilization is at 30%. This is what hurts your credit score the most too.
To counter this impact on your credit a good strategy is to contact your financial institution to request an increase in your available balance.
To the Max
Maxing out credit cards – is a sign that you are heading for trouble. Another utilization issue that must be taken into consideration. Financial institutions track your spending habits and the current financial market. Therefore, if you start heavily using your credit cards, they are going to make a note of this. The most effective recourse for any financial institution is to cap your credit use by reducing your available credit balance.
This can also happen during a financial downturn. I have been a great customer of a certain bank however, in my 30+ years of credit history twice they have lowered my available credit levels substantially. Once during the great recession of 2007 and again during the 2020 pandemic. This was a temporary ding on my credit score but not enough to hurt.
To counter this consistently pay off your balances every month.
Bankruptcy eliminates your responsibility of paying part or all your debt because of circumstances in your control or not. The bankruptcy court will always have the final say. The bankruptcy will remain on your credit report for 7 to 10 years. However, during this time you can make every effort to improve your credit score and gain control of your finances. Learn more about Bankruptcy’s impact on your credit score from Debt.org.
To counter this research and seek financial counseling before making this decision.
Is the action of taking possession of a mortgaged property when the mortgagor fails to make the monthly mortgage payments. Foreclosures remain on your credit report for seven years from the date of the first missed loan payment. It will fall off your credit report on its own. Review more about foreclosures from Experian.
To counter this seek financial counseling to help review the options available.
Pin for later
What Hurts Your Credit Score the Most – The Not So Obvious
These not-so-obvious things are what hurt your credit score the most. These are some of the good things we do that hurt our credit rating that we may or may not be aware of. Such as length of credit, new credit, credit mix, paying off loans, closing credit accounts, debt settlement, and loan modification.
Length of Credit
How long you have had credit counts for 15% of your credit score. Therefore, it is important to establish credit early. Having a credit history that spans 10+ years is optimal. Avoid the pitfalls of being irresponsible with your credit cards. This leads to debt problems and bad credit. To maintain a strong credit history never charge what you are unable to pay off each month. Credit cards are not an emergency fund. Establish your emergency fund to handle unavoidable and unexpected expenses. Learn how by reading Emergency Fund.
New Credit applications
Credit inquiries are applications for new credit. In a Nutshell – A hard credit inquiry may impact your credit scores and stay on your credit reports for about two years, while a soft credit inquiry won’t affect your scores per CreditKarma.com. A Hard Inquiry occurs when a financial institution checks your credit score to determine if they should extend your credit. Typically, this takes place when you apply for a mortgage, loan, or credit card. This inquiry can sit on your credit report for 2-3 years decreasing your score until it drops off. It counts for 10% of your credit score.
On the other hand, a soft inquiry is when you do not give your permission to have your credit score pulled. Hence it does not affect your score. Typically, financial institutions use this inquiry to prequalify you for a credit card, checking your credit through a banking or credit app (i.e., CreditKarma.com). Also, prequalified insurance quotes and employment background checks.
The credit mix makes up 10% of your credit score and is part of what hurts your credit score the most. Besides credit cards, there are many other types of credit. Such as car loans, mortgages, student loans, and personal loans. Personal loans also include a home equity line of credit. A home equity line of credit (HELOC) is a personal loan that uses the equity in your home as collateral. It is considered a second mortgage on the home and is paid for in addition to the mortgage. It is different from a cash-out refi where your current mortgage loan is replaced. Your new mortgage will have an increased loan amount (which includes the cash-out amount plus the remaining mortgage), new term, interest rate, and monthly payment.
Maintaining a good mix should include both installment loans and revolving credit. Installment loans are where you borrow a specific amount and have a set number of payments to be paid monthly for a certain length of time. Revolving credit has no set borrow amount and you pay the minimum payment each month or the full amount. For example, a good mix would be having a mortgage (installment), an auto loan (installment), and two credit cards (revolving) is a good mix and will keep your credit score in good standing.
Paying Off Loans
Paying off loans reduces the loan mix and can turn a good thing of becoming debt-free into something bad. It can temporarily reduce your credit score. For instance, paying off my car note reduce my credit score for a few months. Since I still had a mortgage and several credit cards, I still had a decent credit mix. Credit mix may not be the most important factor determining your credit score, but it is what hurts your credit score the most.
Closing Credit Accounts
When you close an account, you are affecting your overall credit mix. It is very similar to paying off a loan. Hence, you could be creating an imbalance in your credit mix. You will also reduce your available credit line. Thereby, negatively affecting your credit utilization. When you compare the reduced available credit to your current outstanding balance, it could lead to an increase in the utilization percentage where you want to remain under 30%. See the example above under the Monthly Balances header.
If you find that you have a card that you are not using or it might have a fee attached to it or you want a card that has better perks consider changing or upgrading the card. This is a much better choice than just canceling the card. Contact your financial institution to see if there are options to better meet your needs.
A Debt Settlement (debt relief or debt adjustment) is resolving delinquent debt for less than the amount you owe. However, Debt Settlements without a deletion from credit reports are not in your best interest. If you are going to settle or pay your debt in full either to a credit agency or back to the original lender, negotiate the final terms that include a complete deletion from your credit reports. Get this in writing. Understand, you do have some leverage here as they are both trying to get you to pay your debt. Therefore, you should get something as well. Therefore, I cannot stress how important it is for you to get the complete deletion of negative remarks removed from your credit report in writing.
In trouble but looking for some help should never be what hurts your credit score the most. Loan modifications are designed to work with the loaner to reconcile back payments instead of defaulting. Trying to avoid foreclosure or bankruptcy should not be what hurts your credit score.
How far will your score drop?
Let’s review the impact of each of the situations that can hurt your credit the most.
After filing for bankruptcy your credit score can drop from 130 to 240 points depending on if your credit score was average to good or above average. In either case, we are looking at a credit score of about 530 to 580 after filing for bankruptcy.
Foreclosures typically drop your credit score from 100 to 160 depending on if you had a good credit score versus an excellent score.
Your credit score could slowly drop by up to 100 points if you continue to increase your credit balances, apply for new credit and loans, or close accounts.
A credit score could drop by 40 points after paying off debt. This could be short-term depending on your current credit mix and if you had decent credit to start.
Your credit score If you make a late payment and receive derogatory information on your report could drop by 30 points or more. This may require some work on your part to get this information removed. It can be done by writing letters to challenge this information but it will take some time to accomplish.
Keep all this in mind when making money moves that could have long and lasting effects on your credit score because all of the above items are what hurts your credit score the most.
The Need for Good Credit
Why do you need to have and/or keep a good credit rating? Regardless of what Dave Ramsey says unless you are currently a millionaire and have several hundreds of thousands of dollars laying around you are going to need to finance a home, a car, etc. You can save for some things but not all the things you will need. Also, consider that some jobs are sensitive and may require a background check and a credit check to verify your financial stability.
Finally, consider the trust every business needs to conduct business with you. They are advancing services and goods with the expectation that you will pay on time what is owed. It is an honor system. Therefore, your credit score is the only matrix available to them. To learn more about improving your credit score read How to Raise your credit score 100 points in 45 days. The need for good credit is why you should avoid what hurts your credit score the most.
From everyone who has been given much, much will be demanded; and from the one who has been entrusted with much, much more will be asked.Luke 12:48b
Your credit score can determine the following:
- The interest rate you pay
- Getting additional credit for a mortgage, car, credit card, or personal loan
- If you are hired for certain jobs
- leasing an apartment
- How much you will pay for a car and home insurance
- Obtaining utilities for your home, apartment, or service for your cell phone
Credit Score Factors
- Payment history (35% of your score)
- Utilization (30% of your score)
- Length of credit history (15% of your score)
- New credit (10% of your score)
- Credit mix (10% of your score)
What Hurts Your Credit Score the Most Overview:
- Late Payments
- Monthly Balances
- Maxing Out Your Credit
- Length of Credit
- New Credit / Inquiries
- Credit Mix
- Paying Off Loans
- Closing Credit Accounts
- Debt Settlement
- Loan Modification
I hope you found these tips on what hurts your credit score the most helpful.
Here are additional resources:
Let’s Budget, Spend, and Live!