Your credit score and credit report can seem like elusive concepts – you know what each one is, but do you truly know how your credit score is calculated, and what your credit report reveals about you?
While it is extremely important to be financially responsible by paying off your bills and not accruing debt, it is also wise to have a full understanding of your credit score and credit report, especially if you are a current and potential borrower. Unfortunately, there are many myths that may cloud your judgment and your self-assessment.
1. “I can boost my credit score by using prepaid credit cards and debit cards.”
Prepaid credit cards and debit cards are not reported to the credit bureaus, so using them doesn’t affect your credit score either way. If you are unable to obtain credit cards but want to boost your credit, use a secured credit card instead. A secured credit card requires you to put up collateral to obtain the card, such as a car, boat, expensive jewelry, or an entire bank account. When you use the card responsibly, over time, your credit score increases, and then you can apply for a traditional unsecured credit card.
2. “Every time someone pulls my credit report, it decreases my credit score.”
Whether your credit score is affected by someone pulling your credit depends on how they pull your credit report. What is known as a “hard inquiry” can decrease your credit score; however, if it is a “soft inquiry” then it does not.
When you apply for a loan or a credit card, the creditor pulls your credit report. This is a hard inquiry. While a hard inquiry does affect your credit score, it is typically only by a few points. Additionally, when you apply for a similar type of loan (such as an auto loan) with a few different creditors, this typically counts as one inquiry if completed within a 30-day time-frame.
A soft inquiry is when a creditor reviews only a portion of your credit report for educational purposes. Generally, a soft inquiry is something a credit card company does before sending you a pre-approval notice in the mail. When you pull your own credit report, this also does not affect your credit score.
3. “Only certain types of unpaid bills show up on my credit report and affect my credit.”
The types of debts that show up on your credit report are at the sole discretion of the creditor. If the creditor reports the paid and unpaid debts to the credit bureaus, then even public library fines that have been turned over to a debt collection agency can show up on your credit report.
It is true that certain creditors are known to report all paid and unpaid debts to one or more credit bureaus. Mortgage companies, credit card issuers, and even apartment complexes are some of the common types of creditors that report the state of your accounts to the credit bureaus. If you are unsure about whether a creditor or an account holder reports to the credit bureaus, simply make an inquiry.
4. “Salary, child support, alimony, and other income affects my credit score.”
Income, whether individual or household, is not used to calculate your credit score. While the credit bureaus do not publish the exact formula used in credit score calculation, FICO reports the general calculation: Payment history accounts for 35% of the score, account balances make up 30%, credit history is 15%, the various forms of credit you have account for 10%, and new credit applications make up the last 10%.
You may make a lot of money, but that doesn’t necessarily mean you have good credit. Good credit is built by paying your bills on time and prudently managing your financial accounts.
5. “Since I don’t have any credit cards or credit card debt, I have a good credit score.”
Not having any credit cards does not ensure that you have a high credit score. On the contrary, having credit cards and properly managing them plays a big role in calculating your credit score. It is imperative to develop a credit history, which includes establishing credit accounts and paying off debt.
Creditors and lenders want to see that you have and can manage credit cards. When a creditor or lender sees that you do not have any credit cards, it will likely view you as a higher risk than those who have credit cards. It is wise to have at least one credit card as part of your overall financial management strategy.
6. “Closing credit card and other credit accounts increases my credit score.”
Closing credit cards and credit accounts that you don’t use does not increase your credit score. In fact, closing these accounts can decrease your credit score, as this decreases the amount of credit available to you.
The concept that comes into play here is credit utilization, which is the amount of credit you use compared to the amount of credit you have available to you. Creditors are more interested in how well you manage your credit accounts, so they want to see you have a lot of credit available, but are using relatively little of it.
If you must close an account, close one that is newer, rather than a long-term account. The length of your relationship with the creditor positively impacts your credit score. You can also close accounts with lower credit lines over those with high credit lines.
7. “Asset accounts, such as checking, savings, and investment accounts, affect my credit score.”
Income, checking accounts, savings accounts, and investment accounts are not reported to the credit bureaus. Therefore, they do not affect your credit score.
8. “Only one credit score exists.”
Numerous credit scores exist. Beacon and FICO are two of the most popular credit scores creditors use. Each creditor or lender chooses the credit score that they look at to make a credit decision. One report can contain multiple credit scores, and each score can vary greatly to each other. When you are applying for a loan or credit account, ask the creditor or lender which credit score it reviews.
9. “You only need to check your credit report if you know you have credit problems or don’t pay your bills on time.”
Everyone should check their credit report at least once per year, as it is not uncommon for items to show up on your credit report that are in error. The only way to know what these errors are is to monitor each of your three credit reports. Consumers are entitled to a free copy of each of the three credit reports once every 12 months, so use your right to ensure that your credit report is a correct reflection of your credit history.
10. “Paying off negative debt removes it from my credit report.”
Your credit report reflects your credit history, which includes positive and negative accounts. This means that late payments, collection accounts, discharges, and bankruptcies can remain on your credit report for 7 to 10 years.
It can be difficult to fully understand your credit score and credit reports, but understanding the myths that surround them can clear up a great amount of mystery. A great credit score can make the difference between approval and denial of various types of loans and credit accounts, and can also mean better interest rates, job prospects, and auto vehicle insurance rates.
Have you checked your credit report in the last 12 months?