5 Common Credit Score Myths and Misconceptions

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5 Common Credit Score Myths and Misconceptions

Many people struggle with understanding the complexity of credit scores and credit reports, and understandably so - the three credit bureaus differ in credit score tabulation formula, we can never be sure how much our credit score actually affects our future, and there’s a lot of misinformation out there.

A credit score is a measure of your creditworthiness - it reflects your credit actions, and therefore your financial responsibility and maturity, at least to credit lenders. It is merely an algorithm-based assessment of you as a consumer, and it is the equivalent of your potential lender visiting everyone you pay your bills to and asking: “Can I trust this person to pay me back?”

There are five components to the FICO score, the most commonly known scoring system: payment history (35%), credit utilization (30%), credit history length (15%), types of credit (10%), and number of credit inquiries (10%). A score of anything below 649 counts as poor or bad, 650 to 699 is fair, 700 to 749 is good, while everything over 750 ranks as excellent.

Even though we now know so much about credit scores, there is still a lot more to learn, and a lot more to unlearn. Here are some of the things people believe about credit scores that are just not true.

1. Checking your credit score hurts your credit

If my credit score increased by one every time I heard someone say this, I’d have it stuck right at 850, only because it can’t go higher than that. I understand why people are reluctant to “risk” lowering their credit score by checking it - no one wants to undo their hard work just because they’re curious. This doesn’t apply to soft inquiries, however, so there’s really no reason to panic. FICO can recognize when credit is seeked, and you trying to check your credit score is obviously not seeking credit.

Most credit score monitoring apps out there, credit cards which offer free FICO scores as part of your monthly statement, pre-approved offers, or job offers are merely soft inquiries, which means that they leave no mark on your credit score, no matter how many times it’s checked. This misconception comes from the fact that hard inquiries knock a couple of points off your credit score, but you go through a hard inquiry only when a financial institution pulls your credit report in order to approve you for a mortgage or credit card. So, as long as you’re not trying to borrow money left and right, your credit score is safe and sound.

Besides, knowing your credit score will give you a clear idea of where you stand and which of your habits (or lack thereof) are impacting your credit. If you plan on applying for a car loan, home loan, or credit card, it’s important to know if your creditworthiness needs to be improved before you apply - you could end up dodging higher interest rates or being denied a loan.

You are entitled to a free copy of your credit report every 12 months from each credit reporting company. It’s crucial to keep track of your credit history, as mistakes occur, and you never want to be responsible for something that you didn’t do. So, keep an eye on your credit score, and dispute any errors which may arise.

2. Not using your credit card hurts your score

Credit card utilization makes 30% of your credit score. This is why many believe that not making any purchases on their credit card hurts their score, but that’s not correct, or at least not entirely. Here’s the catch: if you only have one credit card which you don’t use, your credit score might go down. However, as long as you use any type of revolving credit, your credit score will be unaffected.

If you happen to have multiple credit cards, including all-purpose credit cards, travel rewards credit cards, co-branded credit cards, or store credit cards, at some point you’ll realize that you don’t wanna use one of them. This is perfectly fine, as long as you’re somewhat actively using at least one credit card. Lenders want to make sure that they can trust you with unsecured credit, and if you don’t use any credit at all, they can’t know your financial behavior. However, if you use one credit card at least, that should give them enough information about your habits.

Another thing to consider is the fact that inactivity sometimes may lead to cancellation of your credit card, as credit card companies sometimes close accounts which have been inactive for six months or longer. This can potentially hurt your score, but only due to lack of understanding your own situation. If a credit card of yours is cancelled, your available credit goes down, which means that your utilization might increase, thus increasing your score. If you happen to neglect your oldest account, or get it cancelled, your credit history length might also go down, which can negatively affect your score, especially if all your other credit cards are fairly new.

Other than that, credit card inactivity does not directly affect your score, it merely keeps your utilization low, while your credit history length increases.

3. Carrying a balance and paying interest boosts your credit score

It’s quite shocking that people believe this, but they do. You are not obligated to pay interest in order to be deemed worthy by your bank or lenders. Additionally, you do not need to pay interest for a good credit score - it just doesn’t work that way!

The interest that you pay on your credit card is not reported to credit bureaus. The FICO algorithm uses the following three criteria when calculating your utilization: statement balance, available credit, and whether you paid off your balance on time or not. APR values are already high enough as they are, and you really can’t afford to accrue interest on payments that you can be making.

Many people swear by this “hack”, claiming that it helped them increase their credit score. However, there’s no correlation between paying interest and a high credit score - those people simply built the same payment history that any other credit card user who does not pay interest is building. As long as you pay off all your balances in full every month, your credit score will be in good standing.

The whole point of a high credit score is the ability to land lower rates on loans you want to take out. So, why throw money down the drain for absolutely no cause?

4. A bad credit score can’t be fixed

A credit score is a snapshot of your financial behavior at a certain point in time: changing as years go by, dropping when you make a slip-up, and healing when you get back on your feet. Things that you don’t want your credit report to show impact it less each year.

Usually, late payments are reported up to 7 years from when the delinquency occured, as well as charge-offs, foreclosures, or short sales. Hard inquiries affect your score slightly, and generally remain on your report for 2 years, but affect your score for 12 months.

Lastly, it’s possible for things to be mistakenly reported, in which case it’s important to dispute any potential error. This is why it’s always a good idea to keep track of your credit score and report.

5. Taking out installment loans boosts your score

Taking out a loan simply because you want to boost your score is really not an excellent idea. Remember, the end goal is not to have the perfect credit score, the end goal is to be able to get a lower rate on a loan you actually do want.

Credit-seeking activity makes up only 10% of your credit score, and as such is really not worth paying interest on an installment loan you took out only to see that three-digit number sky-rocket. In reality, the changes on your credit score would be minimal, while your amounts owed could increase.

An alternative to this is simply getting a credit card, that you actually will use, and pay off in full each month.

Keeping your credit score in the higher digits is no easy task - many people struggle with it. What you need to do is always be informed and do your research before you make any financial decision, even if it seems minor to you. Everything you do needs to be based on your desired future. There’s no other word for it, but with this stuff you just need to be calculated.

It’s a good idea to check your score every once in a while, because it is an insight into your own financial habits, and can guide you in the right direction. Whatever happens, remember that you can increase your credit score for the wonderful price of $0 - no need to pay any interest.

Finally, if you do make a mistake - miss a payment, close a bunch of cards at the same time, or apply for a couple of them in a short amount of time - don’t panic. Your credit score forgets mistakes, eventually.