Eight Myths About Your Credit Score
By Lita Epstein, credit and debt expert, WalletPop.com
With debt a big part of modern life, many people know they have a credit score and it
determines whether they can obtain a loan at a decent interest rate. But after that,
confusion reigns. In this series, I explain how the number is calculated and debunk eight
myths people have about their score.
The most important thing people need to understand about credit scores is what goes into the
calculation. Payment history accounts for 35% of your score. The amount that you owe accounts
for 30%. Next in line is credit history, which makes up 15% of your final score. Applications
for new credit and types of credit in your record each account for 10% of your score.
Credit scores range from about 300 (lowest) to 850 (highest). Generally the best interest
rates go to people with a score above 750. In todays tight credit environment you will have
difficulty getting credit with scores under 650 and will likely be forced to pay much higher
interest rates.
Myth No. 1: You Have One Credit Score
There isn't just one type of credit score. In fact, there are at least six primary ones that
are given to consumers and many more assigned to businesses. The primary driving force behind
most of them is the Fair Isaac Corporation, known by most as FICO.
Each of the three credit reporting agencies has a slightly different formula for calculating
scores, but all are developed by FICO. Equifax's is called BEACON, TransUnion's is called
FICO Risk Score and Experian's is called FICO II. You'll find your credit score is not
exactly the same at each agency, but scores should be within 20 points of each other.
In addition to these, Fair Isaac has come up with some new alternatives that the agencies may
offer. Plus, there is scoring done for insurance companies and other businesses that use a
different set of parameters. In many states, your insurance premiums can be higher if you
have a low credit score.
Myth No. 2: You Should Close Cards to Improve Your Credit Score
Sometimes when you apply for a loan for a major purchase, such as a mortgage, you're told you
can improve your credit score if you close some of your credit cards. Don't believe it. In
fact, sometimes when you close an older card you can actually cause your credit score to go
down.
That happens for two reasons. First, the best scores go to people who use credit moderately
over a long period of time, so the older the cards, the better. If you need to close some
accounts, close the newest ones first so you retain the cards with the longest history of
prompt payment. If you don't have a credit history you'll find it very hard to get a major
loan when you need one.
Second, credit scoring agencies put a lot of emphasis on what is called your utilization
ratio. It is essentially your total debt as a percentage of all your available credit. If
you lower your available credit by closing cards, your utilization rate can actually look
higher, hurting your credit score.
Myth No. 3: Lowering Your Credit Limits Can Help Your Score
In most cases, lowering your credit limits will likely hurt your credit score. That's because
credit scoring companies emphasize the debt utilization ratio (total debt as a percentage of
all your available credit). Suppose you have $20,000 total credit available to you on four
cards of $5,000 each. You carry a total of $6,000 in debt on those cards. The debt
utilization ratio would be 30% ($6,000/$20,000).
Now suppose you close one of those cards and your total credit available is $15,000, but you
still have $6,000 in debt. Now your debt utilization ratio would go up to 40%. That move
could actually lower your score by 50 to 100 points because it looks like you're getting
yourself into deeper credit trouble.
If you want to improve your credit score, don't reduce your available credit. But do pay down
your debt as quickly as possible. People with a debt utilization score of 10% to 20% get the
best credit scores as long as they are paying their cards on time.
Myth No. 4: You Must Pay Off Your Cards in Full Each Month to Get a Good
Score
You may think you have to pay down all your credit cards to zero to get a good credit score.
That's not true. In fact, to show you know how to use credit wisely, it doesn't hurt to
occasionally pay a card over time. Showing you know how to use credit wisely can actually
help you get a better credit score.
If you don't buy on credit and pay everything with cash, you'll likely have a lower credit
score because you have no credit history for the credit scoring agencies to use. This not
only hurts your credit score, but it can also impact your insurance costs because insurance
companies do use your credit score when determining rates. They believe people with a higher
credit score file less claims and therefore are lower risk, so they get the best insurance
rates as well as the best interest rate offers.
The ideal way to use credit is to use 10% to 20% of your available credit and pay all bills
on time. That seems to get people the best credit scores. It shows the credit rating
companies that you know how to use credit wisely and you know how to pay your bills on time.
Myth No. 5: Shopping for the Best Credit Rates Can Hurt Your Score
If a loan officer tells you that you shouldn't shop for the best interest rates because it
will hurt your credit score, don't believe them. They're just giving you a line to keep you
from comparison shopping.
Whenever you shop for rates within a short period of time, the credit scoring agencies lump
these requests into one inquiry. For example, if you apply to four different mortgage lenders
within a two-week period, it would count as just one "hard" inquiry against your score. Don't
drag out your search too long or the credit scoring company may end up counting the inquiries
separately.
Also, don't apply for a new car loan or a new credit card just before you apply for a new
mortgage. You will lower your score and you will likely end up with a higher interest rate on
your mortgage.
Myth No. 6: Checking Your Credit Score Can Hurt Your Score
Contrary to popular belief, you can not hurt your credit score when you ask to see a copy of
it -- as long as you do it yourself and don't ask a friend at a financial institution to do
it for you. When a bank requests a credit report, it is usually tracked as a "hard" inquiry,
which prompts the credit reporting agency to presume you've made an application for a new
credit card or another kind of loan. That's when it hurts your credit score.
When you request a copy yourself, it's considered a "soft" inquiry and does not impact your
score at all. If you want a free copy of your credit report, you are entitled to one free
copy a year from each of the three top credit reporting agencies.
You definitely should check your credit report from each of the credit reporting agencies
yearly to be sure no one is using your good credit name and to be sure all your credit
accounts are being reported accurately.
Myth No. 7: Paying Your Cards in Full Will Give You the Best Score
Even if you are someone who pays their cards in full each month, you might not have the
highest credit score. Most people pay their credit card bills after they receive them in the
mail. But, if you do that, the credit reporting agency ranks your credit based on that
outstanding debt even if youre going to pay in full in 10 days.
For example, if you have a $2,000 credit limit and used $1,000 of that credit, the credit
utilization on that card would look like 50 percent. If you want to improve your credit score
quickly, pay your outstanding debt before the credit card company reports. Since reports are
usually sent monthly right after the end of a billing cycle, pay most of the bill in full a
few days before the billing cycle ends. Leave 10 or 20 percent of the amount due on the card
for reporting purposes. If you do this for a few months before applying for a mortgage you
should see a nice improvement in your credit score because your debt utilization ratio will
look much lower.
Myth No. 8: Putting a Statement in Your Credit File Can Help Your Score
Some people think they can fix a credit score problem by putting a statement in their credit
file. It's probably a waste of time. While the law does require that credit reporting
agencies allow you to submit a statement of explanation when you dispute a negative mark on
your credit report, these letters dont go into calculating your credit score. Many lenders
make credit decisions based purely on scores.
What can you do if you are in a dispute over payment? While credit scoring companies must
investigate any credit information you challenge, they will only take a negative mark off
your report temporarily while investigating and they tend to agree with the vendor in ongoing
disputes.
If you've been battling it out with a creditor and don't want to pay the bill, you could end
up severely damaging your credit score. You may be better off paying the bill and taking the
vendor to small claims court for a refund. If you want to fight, be sure you tell a potential
creditor to expect the negative report and explain why you won't pay the bill.
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