4 Ways You Can Have a Low Credit Score Despite Paying Your Bills on Time

By Sean Williams Markets Fool.com


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Whether you realize it or not, your credit score can have a major impact on more than just your finances. We often think of our credit score as influencing our ability to get a mortgage, take out a loan, or open a new credit account. But your credit score (also known as FICO score), which ranges from a low of 300 to a high of 850, can have far-reaching implications beyond your ability to get a loan from a bank or credit union.

For example, landlords and employers may ask to see your credit report prior to renting to you or hiring you. While landlords might be willing to overlook a late payment from time to time, finding a collection or repossession on your credit report could deny you a desired apartment or house. Similarly, employers could view late payments and repossessions as a lack of responsibility and choose not to hire you.

Your credit report can also influence your insurance rates and what you might owe to set up a utility account. Insurers have demonstrated via studies that people with lower credit scores are costlier than those with higher scores, therefore some insurers charge people with lower credit scores a higher monthly premium. Likewise, while utilities (e.g., electric or water) can't deny someone service based on their credit report, they can require a higher deposit before starting service to those with late payments, collections, and repossessions.

Thus maintaining a high credit score is not only imperative for getting the loan you want at an attractive rate, but it could also be pertinent when it comes to renting, job hunting, and purchasing insurance.


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Four ways your credit score can still be subpar with on-time payments

There's more to a good credit score than just paying your bills on time. Though FICO suggests that on-time payments account for the largest portion of your FICO credit score calculation, that is by no means the only factor considered. There are four ways, in particular, that you could potentially have a poor or below-average credit score even if you're always on time with your payments.

1. High credit utilization

One of the easiest ways to have a below-average credit score despite making your payments on time is to make poor use of your available credit.

In general, credit reporting agencies (of which there are three) don't like to see consumers use more than 30% of their available credit. For example, if you have three credit cards each with a $5,000 limit ($15,000 total), the credit reporting agencies would likely ding your score if you used more than 30% ($4,500) of what was available to you. Lenders view high usage of credit as potentially unsustainable and irresponsible, and it may also be a red flag to future lenders should you seek to open new accounts.

2. Only having one credit card

Most consumers have that go-to credit card in their wallet they prefer to use, either because of its convenience, or perhaps because of the mileage or cash-back rewards they receive. Unfortunately, using only one credit account could leave you with a lower-than-ideal credit score even if you have a pristine payment history.

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Credit reporting agencies like to see that you have the ability and responsibility to handle multiple accounts at the same time, as well as different types of loans. For instance, credit agencies will look to see that you can handle revolving credit accounts, such as a bank credit card or a department store credit card, as well as an installment loan, such as a car loan or mortgage, which is a fixed monthly payment. The more capable you seem at handling these multiple accounts and loan types, the higher your credit score will be.

3. Opening too many new accounts

At the other end of the spectrum is the danger of opening too many accounts. Although there is no ideal number of accounts to have open, you'll certainly want more than one for the reasons noted above, but not so many that you're causing constant damage to your credit score because of regular hard inquiries by lenders.

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So when should you open a credit account? The general rule is to do so when it makes sense. For example, buying a house, a car, or even an expensive item such as a stove or refrigerator is a decent reason to open a line of credit. Most people don't carry the kind of cash necessary purchase a house or a car on the spot, so a loan makes sense in these situations.

However, saving 10% on a $19.95 pair of pants at your local department store probably isn't worth opening a credit account. If you plan to shop there often, and there are potential cash rewards or incentives, then opening a department store card to save 10% now -- and more in the future -- might make sense. But more often than not, it will just wind up hurting your credit score.

4. Having a relatively short payment history

Finally, credit reporting agencies take into account how long you've had your accounts open when calculating your credit score. If you've been perfect with your payment history, but you've only had your account(s) open for a few months, then don't expect your credit score to be exceptionally high.

Credit reporting agencies view your credit activity as a roadmap: The more data points you provide, the more reliable and statistically significant the data. If you've only made payments on time for six months, then there's still enough doubt from lenders and credit reporting agencies that you could be a risk. However, if your average account has been open for eight years, and you've never been late, then you've built a track record of responsible credit usage.

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Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.

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