Does opening an IRA affect your credit? No, it doesn’t. Cashing out your IRA doesn’t affect credit scores either. Actions you take concerning your retirement accounts have no direct bearing on your credit scores.
Your ability to manage your debt is what has a direct impact on the scores within your credit report. Since IRAs are a savings vehicle for retirement purposes, they are not directly related to your credit history. However, what you do when you cash out an IRA can indirectly affect your credit scores.
What Factors Directly Affect Your Credit Scores?
So, if your IRA activities don’t affect your credit scores, what does? Well, various factors affect your credit scores. Below are some of them.
1. How Much Debt You Carry
Did you know that your debt affects 30 percent of your FICO score? That’s how important it is.
The reason what you owe matters to lenders is that it indicates your ability to pay them their money now and in the future. If you have huge debts, it means you may struggle to meet all your financial obligations at some point. So, you will come across as a high-risk borrower, and your scores will go down.
Of particular interest to lenders is your credit utilization ratio, which refers to how much you owe compared to your overall credit limit. The higher this ratio is, the more likely you are to max out your credit cards. So, you need to keep it below 30 percent. It is indicative of your inability to manage your debts by paying them down. For this reason, it is generally recommended that you don’t close your unused cards.
2. Payment History
Payment history affects 35 percent of your credit score. When lenders look at your history, they want to know whether you can pay your debt in time or not. They also want to understand whether you can pay your debts at all. So, they will pay close attention to bankruptcies, wage attachments, late payments and payments currently being made on time.
You may want to contact your lenders and ask them for help in improving your payment history. They can do that by moving your due dates or reducing your debts or interest.
If you have a poor payment history, your credit scores will reduce over time. However, if you made mistakes in the past but make an effort to correct them, your scores will start to increase.
3. Credit History Length
The length of credit history will account for 15 percent of your FICO score. Lenders usually take a good hard look at the age of your credit accounts and when you last used them.
The longer your credit accounts have been in operation, the better. That’s why it’s crucial to establish your credit history as early as possible. If you are late in doing so, you can start by opening a secure credit card or signing up for a credit card with a co-applicant with a good credit score.
4. New Credit Information
If you shop around a lot for new credit, you may come across as desperate for money, which could indicate financial difficulty. Opening up new credit accounts also lowers your average credit age, thus lowering your scores even more. In addition, it may put you in a position where you end up owing more debt. Therefore, lenders may consider you a high-risk borrower.
5. Credit Mix
Credit mix refers to the different types of debt you owe lenders. These include car loans, credit card debts, etc., usually categorized as balance, installment and revolving debt. Mortgages are also part of the mix. Typically, your credit mix will affect 10 percent of your FICO score.
How Individual Retirement Accounts Funds Indirectly Affect Your Credit Score
Cashing out an IRA before you are 59.5 years old is not advisable unless you meet other qualification criteria. That’s because you may be forced to pay penalties. In addition, you will lose the tax advantages, and your withdrawals will be subject to taxation. Also, you will lose out on a significant amount of future earnings since you will have less principal in your retirement accounts.
Currently, you could cash out an IRA if you meet the eligibility criteria set out in the CARES Act to obtain relief from the Covid-19 pandemic situation. You can also choose to ignore the tax and penalty implications and cash out your IRA. However, if you use the money strategically, you could indirectly improve your credit score.
Below are some of the ways you can achieve that improvement.
- If you use your cash to pay your debts, you can reduce the amounts owed and the credit utilization ratio. That, in turn, will improve your credit scores.
- If you have a poor payment history and want to stay current on your debts, you can use your IRA funds to get rid of late payments. And considering that bankruptcies can remain on your credit reports for anywhere from seven years to 10 years, it would be wise to avoid them. So, if cashing out your IRA can help you do that, it may be worth the financial hit you take.
- You could compromise your ability to access more significant business credit if you have a bad business credit score. So, rather than increase amounts owed to lenders and suppliers, late payment amounts and your credit utilization ratio, you could use some of your IRA funds to pay off your current business loans. Doing so may save your business and give you enough time to make it successful.
- Cashing out your IRA can also enable you to fund your business startup if you cannot access credit anywhere else. And once your business is up and running, you can open credit accounts and begin improving your credit scores. In this case, you can use a self-directed IRA or implement other methods, such as the 60-day distribution or Rollovers as Business Start-ups (ROBS).
Assess Your Situation
Whether or not you use the funds in your retirement accounts to improve your credit scores depends on your debt situation. But you should avoid cashing out them out early where possible.
However, there’s no point in getting sued or losing a roof over your head if you can find a way to forestall that. But you need first to ensure the math makes enough sense to justify borrowing from your future self. If it does, then you can consider cashing your IRA to improve your credit score, getting rid of choking debts and getting back on your feet. Then you can later fund your IRA again as quickly as possible.
- MyFICO: What is Amounts Owed?
- Experian: How Utilization Rate Affects Credit Scores
- MyFICO: What is Payment History?
- MyFICO: What is the Length of Your Credit History?
- MyFICO: What is New Credit?
- CNBC: Does applying for new credit hurt your credit score?
- EQUIFAX: What is a Credit Mix and How Can it Affect Credit Scores?
- MyFICO: What Does Credit Mix Mean?
- IRS: What if I withdraw money from my IRA?
- IRS: Coronavirus-related relief for retirement plans and IRAs questions and answers
- Forbes: How Long Does A Bankruptcy Stay On Your Credit Report?
- Bplans: Can You Get a Business Loan With Bad Credit?
- GuidantFinancial: Yes, You Can Use Your IRA to Start or Grow Your Business
I hold a BS in Computer Science and have been a freelance writer since 2011. When I am not writing, I enjoy reading, watching cooking and lifestyle shows, and fantasizing about world travels.