How Credit Cards Hurt Your Credit Score

Your credit cards can hurt your credit score in ways that you may not even be aware of.

Today, everyone is concerned about their credit score. The higher your credit score is with  the credit rating agencies, the better things are for you. You will be able to get lower interest rates on credit cards, car loans, mortgages, etc. In fact, the lower your credit score is, the less likely it will be for you to be able to to secure loans and new credit cards.

There are two articles that were published today on this topic. The first article is from LowCards.com via TheStreet.com It discusses why it is very important to avoid retail store credit cards and just stick with the big name credit card, like Visa, Mastercard, American Express, and Discover. Here’s a link to the article in TheStreet.com:

We’ve all been tempted by the immediate benefit — save 10% or maybe even 15% on your current purchase when you apply for the store’s credit card.

But this is not a wise financial move for most consumers.
With interest of up to 30%, store credit cards are not a wise financial move for most consumers. Macy’s credit card has a 24.50% APR.

Most retail stores offer credit cards with interest rates between 23% and 30%, much higher than bank-branded credit cards. According to the LowCards.com Weekly Credit Card Rate Report, the average advertised APR last week among the nation’s 1,000-plus credit cards was 14.04%.

Some cards, such as the Napa Auto AutoCare Easy Pay and the Lane Furniture Credit Card, are charging a jaw-dropping 30% interest on credit card purchases. Goodyear(GT_) and Zales(ZLC_) have 28.99% APR on their cards; the Office Depot(ODP_) Personal Credit Card charges 27.99%; Sears(SHLD_) charges 25.24%; and Macy’s(M_) credit card has a 24.50% APR.

Retail credit cards, also known as private label cards, carry higher interest rates than bank-branded credit cards because they tend to be held by riskier borrowers with fewer credit options. Issuers suffered significant losses on these private label cards during the financial crash of 2008. In fact, General Electric(GE_) and Citigroup(C_), two of the largest issuers of private label cards, indicated that they wanted to sell off their private label business, but both failed to find a buyer.

Default rates have dropped significantly in the past year, though, and private label cards with high rates are more appealing for banks and issuers that need the revenue. According to The Wall Street Journal, Wells Fargo(WFC_) is considering getting into the private label business. Research by Packaged Facts forecasts receivables for private label card programs to reach $152 billion by 2015 (down from the pre-recession of $156 billion in 2007).

There are plenty of reasons to avoid these retail credit cards:

Extraordinarily high interest rates applies to every applicant, no matter your credit score. If you use the card to pay for a purchase and know you can’t pay it off, you should add in the cost of your interest penalties to the price of your purchase. If your interest rate is 29.99% on a card with a $500 balance and you just make the $20 minimum monthly payment, it will take three years to pay off your balance and you will pay $295 in interest payments. Instead of paying $500 for the purchase, you are paying almost $800.

Retail cards can pull down your credit score. Retail cards usually have low credit limits, since merchants want to minimize their financial risk. If you carry a balance, this will increase your credit-utilization ratio, an important factor in your credit score.

If you apply for multiple retail cards, this can can also pull down your credit score for two reasons: Opening these store accounts will lower the average age of the cards in your credit history, and the length of credit history accounts for 15% of your credit score; secondly, every time you apply for a card, the issuer may pull your credit score, which is a “credit inquiry.” Too many credit inquiries can lower your credit score.

The second article is from today’s Arizona Daily Star. This article talks about how the mere fact of closing a credit card can adversely impact your credit score. Here’s the Arizona Daily Star article:

Q: I am holding a store credit card for a store that no longer has physical stores; purchases may be made online only. I want to close that credit card.

Would that affect my credit score, as I start looking for a mortgage loan? Also, I hold another store credit card and am not using it much. Will that hurt my credit score if I am going to close that one, too?

A: You are wise to consider how any changes to your credit profile might affect your credit score, particularly when shopping for a mortgage loan. Without knowing the particulars of your credit profile, it is difficult to know precisely how closing the accounts would affect your credit. I can paint the broad outlines, though, and let you know that closing the accounts probably means a slight, temporary drop in your credit score.

Let’s look at the big picture first. Closing accounts could significantly lower your available credit. That would hurt your credit utilization rate – how much debt you have compared with available credit – and that’s the second-most-important factor that the credit scoring firm FICO uses in calculating your score. Your payment history is the most important.

Also, if you do not have any other revolving credit accounts, closing these two could negatively affect the area of your credit score that involves types of credit used. To achieve the best score, you need to have open, positive accounts that incorporate both revolving and installment terms.

My initial reaction is to tell you not to make any changes to your credit right now. It may be better to wait until you secure your mortgage. The reason is that a drop in your credit score of only a few points may move you into a lower bracket of scores that lenders use to qualify you for loans.

For example, if your credit score is currently 760 and closing one or both of your credit card accounts dropped your score by only five points to 755, it could mean the difference between a mortgage loan at 3.53 percent interest (for scores of 760 and up) and a loan at 3.76 percent interest (for scores ranging from 759 to 700). For a 30-year mortgage loan of $216,000, the higher interest rate could mean paying more than $10,000 more in interest for the life of the loan.

If you have not already done so, I would suggest that you acquire your credit reports from each of the three major credit bureaus – Equifax, Experian and TransUnion – as well as your FICO credit scores from Equifax and Trans-Union. (You cannot buy a FICO score based on your Experian credit report due to a dispute between the credit bureau and the credit scoring giant.) You will want to know what your potential mortgage lenders are viewing when they review your credit. Mortgage lenders will typically review your records from all three bureaus.

Next, determine what interest rate mortgage loan you should qualify for with the lowest of your three credit scores. You can find the average mortgage loan interest rates in your state based on your FICO credit score at http://www.myfico.com

Depending on how good your score is, you may decide to put off securing a mortgage loan until you can improve your credit score and qualify for a lower mortgage loan interest rate. The FICO scores that you acquire from the credit bureaus should include specific tips for you to improve your score.

You may also want to acquire your VantageScore from the three major credit bureaus. This credit score was developed by Equifax, Experian and TransUnion and is being used by more and more lenders. When comparing mortgage loan offers from lenders, be sure to ask which credit score the lender uses in making lending decisions. Also, lenders are now required by the Fair and Accurate Credit Transactions Act to notify you if your credit score adversely affected the interest rate you were offered.