How Your Actions Impact Your Credit Score

Every time you use or abuse your credit, it has an effect on your credit score. The impact varies with the type of action. Positive actions, like paying bills on time, raise your score and lower your risk in the eyes of a lender, insurer, or landlord. Negative actions do the opposite and, depending on what the damaging action was, could be a big deal or a minor and temporary inconvenience.

What factors impact your credit score? Payment history, credit utilization ratio, age of credit history, your credit mix, and new credit inquiries. For example, items in the “small drop” category in the following figure are minimal and can be offset quickly with other positive actions or even the passage of time. Think of them as small meteors that harmlessly burn up in the Earth’s atmosphere. The major and maximum impact items are more like dinosaur-killer meteors!

This figure helps illustrate the recovery time for five different impacts to your credit score.

Turn small purchases into big credit

Because a lot of your credit score is based on using credit and making payments on time, I recommend using small purchases to get back into good standing quickly. Why does making small purchases work so well? Because each item costs less, so more purchases are reported to the credit bureaus faster. My rule is that if it costs more than $10, charge it (and pay it off each month).

Major bank cards certainly report your activity to the credit bureaus. Some store cards may report to only one bureau, or they may not report at all. To find out whether your credit card purchases are being reported and scored, call your card’s customer service number and ask.

If your score is less than stellar, don’t despair. Practicing good credit habits will raise your score over time. Scoring models look at how much of your limit you use. The more you use above a certain percentage, the higher the risk they believe you to be.

To maximize your credit score, spread purchases over more than one card to keep your balance on each card as small a percentage of your maximum limit as possible There is no magic number, but staying under 20 percent to 30 percent of your maximum limit or less is a good goal.

Say you have two cards, one with a $10,000 limit and one with a $20,000 limit. Simply charge twice as much on the higher-limit card to maximize your score. When your balance exceeds 20 percent of your limit, you begin to lose points. So, even if you’re making lots of small purchases, do your best to either pay off the balance each month or keep it under 20 percent utilization. This is one of the fastest ways to see improvement to your credit score.

Pick up some extra points on your credit score by following a simple plan:

• Always pay on time. Your payment history makes up the largest chunk of your credit score.
• Reduce your debt load. Only use credit to the extent that you can pay it off every month or keep your total balance below 20 percent of your credit limit.
• Check your credit report for errors. You can get free credit reports from the credit bureaus by requesting it online or calling 877-322-8228. Send a dispute letter to the relevant credit bureau if you find mistakes.
• Keep your old accounts. Long credit history indicates stability.
• Be patient. It may feel like credit mistakes will haunt you forever, but your payment history from the past two years is more important than your payment history prior to that.

Are you less concerned about your score than about paying down your balances? Some experts suggest that you pay down balances based on the interest rate (that is, pay them in descending order starting with the highest interest rate) to save money on overall payments. Others say that paying off smaller accounts first gives you a feeling of accomplishment, and therefore, you’re more likely to achieve your overall goal. My suggestion is that you choose the approach you find more satisfying. Just be sure that you make the choice; don’t let the first bill that shows up get the extra payment by chance.

Make a list of each credit card, its balance, and its credit limit. Then allocate your payments to reduce your percentage of credit used to 45 percent or less of the limit on as many accounts as possible. Doing so creates some great positive data in your credit report. This approach not only enables you to regain control of your accounts but also helps you maximize your credit score, because accounts that exceed 50 percent of the limit count more heavily against you. When all your cards are at 45 percent of your limit or below, you may want to allocate more money to the highest-interest-rate cards.

If you don’t have a major bank credit card, you may want to try a secured card. You can get one without a fee if you shop around. A secured card differs from a regular Visa or MasterCard in that you maintain a balance in a savings account equal to your credit limit (some cards may allow you more credit than you have on deposit) to guarantee your payment. Secured-card activity is reported just as any other credit card activity is reported, and it affects your credit score in the same way, so it can be a great option if you’re trying to build credit.

You can find great card comparisons at Bankrate or creditcards.com. The latter has two sections to help you find the right card depending on your circumstance. One section is helpful for those with bad or damaged credit. The other section is for those who have little or no experience with credit or who need to start a U.S. credit history (credit from overseas doesn’t follow you).

Generally, in a typical credit market, if you make all your payments on time for a year you should have enough of a positive payment history to get an unsecured credit card.

Maximize your credit score with major expenditures

Big-ticket creditors — those that specialize in expensive products or services — typically report to the credit bureaus. The reason is simple: They have a lot more to lose if they lend based on inaccurate information, so they want to see as complete and accurate a file as possible.

Examples of big-ticket items that may enhance credit activity are home mortgages, cars, boats, student loans, furniture, and appliances. Major credit purchases may give your credit score a boost for two reasons:

• A major purchase is more likely to be in the form of a secured installment loan. Secured means that you pledge collateral on the item you purchase as security for the loan. If you default on the loan, the lender repossesses the security you pledged — in other words, you don’t get to keep the item you purchased. Adding secured credit to the other types of credit you use, such as revolving credit (cards), helps raise your credit score.
• You make the same payment each month. When it comes to credit scoring, making set monthly payments enables the people who figure your score to discover more about your creditworthiness. Making a set monthly payment is a measure of your stability. This is different from paying on a credit card, where you can vary your payments depending on your cash flow. Adhering to a regular payment schedule also indicates that you can handle a higher limit than you may have on a store, gas, or credit card account.