Unless you’re independently wealthy, having a good credit history is essential to a healthy financial plan. But there may be some habits you’ve developed that are hurting your credit score instead of improving it.
These bad habits can also lead you into debt, which can further destabilize your financial plan. To help you understand what kind of habits to avoid, here are 7 unhealthy habits to stay away from.
1. Paying the minimum on your credit card
The minimum payment on your credit card is usually just one to two percent of your balance, and there’s a reason for this. Credit card issuers are for-profit companies, so keeping minimum payments low encourages customers to pay interest.
Not only does paying just the minimum each month cost you in interest and inflate your balance, but it can also hurt your credit by ratcheting up your credit utilization. What’s credit utilization? This is an important factor in your credit score and is calculated by dividing your credit balance by your credit limit. The bigger this percentage is, the greater the negative impact. Experts recommend keeping your credit utilization below 30% to keep it from hurting your credit score.
The takeaway: Try to pay off your entire balance each month, or at least pay off as much as you can.
2. Having no emergency fund
Unexpected things happen in life. As such, you should be prepared financially to pay for unexpected costs. This is what an emergency fund is for.
For example, if your car breaks down or your water heater starts leaking, an emergency fund allows you to cover the cost of the repairs. But what happens if you have no cash cushion? You might instead turn to credit cards or a personal loan. And, if you open a new account, the lender will run a hard credit check, which remains on your credit report for two years. The credit card alternative isn’t so great either as this can run up your balance, increasing your credit utilization to a dangerous level.
For all of these reasons, it’s important to start an emergency fund. If you’re having a hard time coming up with money to save in your rainy day fund, consider paying yourself first. For example, Chime’s Automatic Savings program sets aside 10% of each paycheck in your savings account, making it easier to save without thinking about it.
3. Failing to budget
If you don’t have a budget, you’ll run into two major problems. First, you’ll have a harder time building your emergency fund, especially if you’re just saving what’s leftover at the end of the month.
Second, not having a budget can make it easier to overspend, increasing your dependence on credit to get by. This creates a situation where you’re borrowing when you don’t actually need to.
Creating a budget can sound like a daunting task, but if you start small and get used to the idea, you’ll find a budgeting plan that works for you.
4. Missing payments
Life can get hectic at times, and it can be easy to forget about making payments, especially if you have multiple credit accounts.
However, missing a payment by just a day or two typically results in a late fee. While this won’t initially damage your credit, if you go more than 30 days without paying it, your credit can be negatively affected. It only gets worse when you forget about making a payment for 60 or 90 days.
A late payment stays on your credit report for seven years, according to Experian, one of the three major credit bureaus. You can avoid this entirely by setting up reminders or automatic payments to ensure that you never forget to pay your bills.
5. Closing unused credit cards
This might sound counterintuitive, but hear me out. When you close a credit card, you lower your total amount of available credit by that card’s credit limit. If you have high balances on your other credit cards, it could increase your overall credit utilization and hurt your credit.
For example, let’s say you have three credit cards:
- Card A: $500 balance, $1,000 credit limit
- Card B: $1,000 balance, $2,000 credit limit
- Card C: $0 balance $10,000 credit limit
As explained above in #1, your credit utilization is calculated by dividing your balance by your credit limit. With these three cards, your aggregate credit utilization is 11.5%, which is well below the 30% threshold. But if you cancel Card C, your aggregate utilization jumps to 50%, which can hurt your credit.
Also, keep in mind that an open account helps improve your length of credit history, which is also a factor in improving your credit score.
Of course, there are exceptions to this advice. For example, if you have problems with overspending and leaving the account open is tempting, you may be better off closing it. Also, if the card charges an annual fee, the benefit of keeping it open may not be worth the amount you’d pay to keep it open.
6. Not checking your credit score and report
One of the major factors lenders consider when you apply to borrow money is your credit score. So, keeping an eye on your credit score should be part of your financial plan.
The good news here is that there are several free credit monitoring services that can help you keep track of your score, including Credit Karma and Credit Sesame. These services can also show you which factors go into your score and how you’re doing with each. If your score is low, you can then understand what you need to do to improve it. What’s more, if you notice a big drop but haven’t done anything wrong lately, it might be because of an error or fraudulent activity.
As a result, it’s wise to also check your credit report regularly. You can get a free copy of each of your three credit reports each year at AnnualCreditReport.com. Take advantage of the opportunity and look for anything that’s out of order. If you find something, you can report it to the credit bureaus.
7. Co-signing a loan
If a family member or friend asks you to co-sign a loan, think twice or even three times before doing so. You may want to help, but it’s important to understand how your altruism can backfire.
Co-signing a loan entails a lot more than you might think. By doing so, you become equally responsible for the debt. So, if your friend or family member defaults, the lender can go after you for payment. Also, the loan goes on your credit report for as long as the account is open. If you need to borrow at some point in the future, this may prevent you from getting approved.
Another thing to think about: if your friend or family member needs a co-signer, it may mean he can’t get a loan on his own. Perhaps he doesn’t have a credit history, his credit is bad, or he doesn’t have sufficient income to get approved. As much as you love your friend or relative, this may be too big of a risk for you.
In the end, it’s your decision. If you trust the person and have no reason to believe she’ll default, you may choose to co-sign. Just make sure you understand the risks and how it can affect your credit before you sign the loan application.
The bottom line
If you’ve developed any of the habits here, now is a good time to turn these bad habits into good financial habits. The sooner you do this, the easier it will be to get back on track and improve your financial situation.