Can sound financial habits adversely impact your credit score?

This blog will be relevant to you once you have reached a good maturity for managing your finances but are still unsure why your credit score is not increasing.

Pre Read: All you need to know about Credit Score – Myfinancejournal

I am sure you have come across various blogs that show how your financial habits get reflected in your credit score. I am considering a few exceptional scenarios where you exhibit good financial diligence that might lower your credit score. You need to understand that the basic premise of a credit score is how well you manage the credit available to you. So if you do not make use of your credit then it will reduce your score. I have covered this topic with 3 examples of good financial habits that the credit score companies don’t like.

Mortgage Payments

If you make regular monthly payments to your mortgage, it boosts your score over time. However, If you do not have a mortgage (or if you have pre-paid your mortgage and are no longer making monthly payments) then your credit score would go down. It is a financially sound practice to be debt free; but not from the credit score perspective.

For example, you may have pre-paid your mortgage and have no outstanding mortgage payments or you may have replaced a traditional mortgage with a HELOC where you are paying minimum amount due (Refer to the blog: How to Reduce overall Mortgage Cost – Myfinancejournal). Both of the above are examples of sound financial prudence but are not considered good from a credit score perspective.

Cash Purchases

A similar distinction can be made if you making only cash purchases and don’t have any credit card spend. This shows that you are financially independent and are not in need of credit for your incurred expenses. This habit will, however, reduce your credit score as it means that you are not using the allocated credit and your score may go down.

Effective Use of a 0% Balance Transfer Card

Its a good idea to have a 0% balance transfer card and have the outstanding balance close to credit limit. Why?: Because money is available to you for free! You may use the 0% balance transfer card to make large ticket purchases, retire high interest debt or pre-pay your higher interest borrowing. However, such a transaction will adversely impact your credit score. One of the parameters in your Credit Report: “Credit Card Utilization” would be more than (say) 30% and this will lower your credit score. (Refer to the blog: Save Even More with Balance Transfer Card and HELOC Account – Myfinancejournal)

Credit rating agency would infer from the data that you have a higher % of debt and hence the likelihood of a default is high. Your intentions are planned and deliberately implemented to meet your financial objectives.

Number of Open Accounts and Financial Prudence

Your credit score is a function of the number of credit accounts. When you start off as a young adult, you will have few accounts. As you start acquiring assets like car, home and adding more credit cards, the number of accounts will start increasing.

Sometimes to make the most of the cash back that the cards have to offer, it would be a good idea to have actively use about 3 credit cards. You may have a new balance transfer card every 16-24 months. Over a 10 year period with a sound financial prudence you would have about 10 accounts. Your credit score will be adversely impacted as they are expecting you to have 20 accounts in order to get a full score in this category.

If you have more than 5 active credit cards, it will definitely increase your spend limits. At the same time, you are more vulnerable to fraud on your accounts. Each additional card will require your attention to ensure you do not default. Like making payments, setting up autopay, ensuring adequate balance is available in your bank account when the balance is deducted.

Conclusion

If you have sound financial practices and still see lower credit scores, you should not be very concerned as the parameters that you measure yourself v/s those that the credit score companies measure you are different. Keep going on the path of financial prudence rather than pleasing the credit score companies and trying to get a better credit score.