Your credit score is a very important part of your financial life. Thus, it’s critical for you to really understand what it’s all about and how to make it work for and not against you.
From lenders to landlords, to insurers and utility companies, and even employers… many entities and organizations check credit and credit worthiness before deciding to do business – or have a relationship of any kind – with you. Most often, they perform this check by asking for and receiving your credit score. Your credit score is a number, derived from one of many complex mathematical models, that gives a “snapshot” of what is assumed to be your credit worthiness based on your credit history. In most cases, the number – no matter the model – will range between 300 and 850.
Yet, despite the importance of credit and the credit score, according to a recent survey, many Americans don’t know how the credit score is derived, what factors go into the credit score calculation, or the true downsides to having a poor credit score.
Specifically, did you know if your credit score is a 580, you’ll pay about 3% more in mortgage interest points than someone with a 720 score?
- If you have a $150,000, 30-year fixed-rate mortgage and you get the best rate, your payment will be about $890.
- If your score is poor, your payment would be about $1200 per month for that same loan.
*This is according to Fair Isaac, the company that created the FICO score.
With so much riding on the credit score, it’s important to better understand it and the things that affect it, including credit score myths that are common.
Unfortunately, there is a lot of misunderstanding about credit scores.
Here are 4 of the most common credit score myths and the real deal…
MYTH #1: The major bureaus use different formulas for calculating your credit score.
FACT: The 3 major credit bureaus – Equifax, TransUnion and Experian, MIGHT use different scoring models with different names. In general, however, they use the same or similar formulas for their different models.
A common reason your score might be different with each bureau is because the information in your file with each bureau could be different. For example, some companies only report to one or two of the bureaus or only run inquiries with one or two of the bureaus. Since both of these variables – account history and inquiries – factor into your score, your score would then be somewhat different with each one.
Usually, however, the scores will be similar. If you do notice them varying wildly, it could also be due to inaccurate information in one or more. That’s why it’s important to keep an eye on your reports from all three bureaus and quickly correct any inaccuracies when you see them.
MYTH #2: Paying off your debts is all you need to do to immediately repair your credit score.
FACT: Your credit score is determined by more than your debt balance. Past performance also counts a lot, as well as inquiries. Additionally, length of credit history and available credit matters so don’t just automatically close paid accounts either.
Thus, while it’s helpful to your score to pay off your balances, it’s not going to make your score perfect overnight. It is equally important to consistently get in the habit of paying your bills on time and develop a long established credit history.
MYTH #3: Closing old accounts will boost my credit score.
FACT: As mentioned above, this is a common misconception. It’s not closing accounts that affects your credit score, it’s opening them. Closing accounts doesn’t help your credit score and may actually hurt it.
Yes, having too many open accounts does hurt your score. But once the accounts have been opened, the proverbial damage has been done. Shutting the account(s) won’t then repair your credit and will very likely make the score worse.
Let’s explain a little more…
The credit score is affected by the difference between the credit that is available and the credit that is being used (debt to credit ratio). Shutting down accounts reduces the amount of total credit available and when compared with how much credit you can use your actual credit balances are made to seem larger. This hurts your credit score.
The credit score also looks at the length of your credit history. Shutting older accounts removes “aged” credit history and can make your credit history look “younger” than it actually is. This also can hurt your score.
Summarily, you generally shouldn’t close accounts unless a lender specifically asks you to do so as a condition for them giving you a loan. Instead, the best thing you can do is just pay down your existing credit card debt. That’s something that usually will improve your credit score at least to some degree.
MYTH #4: Shopping around for a loan on big purchases will hurt my credit score.
FACT: When a lender for a big purchase like a car or mortgage makes an inquiry about your credit, your score could drop up to five points. Some borrowers think that if they shop around by going to a number of different lenders for that specific purchase, that each time a lender does an inquiry it will generate another reduction in the credit score. This usually isn’t true. For credit score purposes, multiple inquiries for a loan for a single purchase like a car or home are treated as a single inquiry, as long as they all come within a 45-day period. Thus, it is best to do your rate shopping for big purchases within this 45-day window.
The bottom line is that your credit is literally an important commodity that you own and bad credit can cost you time, money (A LOT in some cases) and even the things (or job or insurance) you want or need. If your credit is not where you want it to be, the time to start working on it using the above tips and suggestions, is now.