Credit scores is a topic shrouded in mystery, confusion, and rumors. This isn’t surprising, given that FICO scoring formulas are secret, although we do know the 5 factors that determine your credit score. To bring light to this confusing subject, let’s shed light on a few common beliefs around credit , each of which is largely untrue.
1. Checking Your Credit Score Hurts Your Credit Score
False. There are two types of credit inquiries: Hard inquiries and soft inquiries. Hard inquiries are when you apply for credit, whether that is a mortgage or auto loan. Hard inquiries require your consent in order to apply, that is, a lender must obtain your permission before running your credit. Hard inquiries will affect your credit score, sometimes by as much as 40 points, although typically, the impact is much smaller.
Soft inquiries do not affect your credit score. One major category of soft inquiries are promotional inquiries, where lenders get access to your credit reports, so that they can send you offers for credit cards, mortgages and more (often by mail). You can opt out of receiving these offers by signing up for Opt Out Prescreen.
Another type of soft inquiry occurs when you check your own credit reports, through platforms like Credit Karma. You can check your credit as often as you wish, without impacting your credit score.
2. You Need A High Income To Enjoy A Strong Credit Score
False. Your salary or income does not appear on your credit reports, nor does it determine your credit score. It is very much possible to build strong credit, even if your income isn’t very high just yet.
For one, you can arrange for someone else to add you as an authorized user on a credit card, which will boost your score. You can follow that up with secured credit cards (which can be opened for as little as $200 or even less). Before you know it, you’ll have a score of 700 or higher.
By the same token, it is possible to earn millions of dollars every year, and yet carry excessive debt, lowering your score. Don’t let income act as an obstacle to enjoying excellent credit.
3. Paying Off An Installment Loan Increases Your Credit Score
(Mostly) false. The FICO formula, which determines credit scores, is made up of five factors. One of these factors, which accounts for 30% of your credit score, is the amount of debt you owe, relative to your debt limits or loan values. The largest part of this factor is your revolving account debt i.e. credit card debt.
In order to maximize your credit score, you will want to keep your credit card debt below 30% of your credit limit (i.e. a balance of less than $300, on a $1000.00 card), for all cards. If you can keep your balances below 10% of your limit, you’ll be even better off.
Your installment account debts (i.e. mortgages, auto loans, student loans, and personal loans), play a far smaller role in deciding your credit score, so reducing balance on those accounts, while a good thing, will often have a fairly minimal impact on your credit score. Some first time homebuyers make the mistake of paying down a large part of their student loans or auto loans, in hopes of increasing their score quickly. That typically does not happen, since these loans are not having as much impact on FICO scores.
4. Closing A Card You Don’t Use Will Improve Your Credit Score
False. Again, let’s refer back to #3, where we mentioned that your debts account for 30% of your credit score. In calculating your overall credit limit on credit cards, the FICO formula takes account of your limit, on each card, and adds these numbers together, and divides your total credit card debt, by that number.
Let’s say that you have 3 credit cards, each with a limit of $1000.00. 2 of these cards are newer (opened in the last year), and 1 is older (it’s been open for 3 years). Your total credit limit is thus $3000.00.
Let’s also assume that you have $700.00 in credit card debt. Let’s say that this debt is divided amongst your two newest accounts, with $350.00 in debt on each account, and $0 debt on the oldest account. $700.00 divided by $3000.00 leaves you with an overall utilization of just over 23%.
Suppose that you now close the oldest account, but you maintain the same amount of debt across your other 2 accounts. $700.00 in debt, divided by $2000.00 in credit limits, is a ratio of 35%. This will almost certainly harm your credit score, given that it is above the ideal debt ratio of 30%.
Also, let’s consider what happens to closed credit card accounts. Any closed credit account will be removed from your credit reports within 7 to 10 years. If you close an account, it’ll eventually fall off your credit reports. Since 15% of your FICO score is the age of your credit accounts, this can reduce the age of accounts, and damage your score.
5. Getting Married Combines Your Credit Score With That Of Your Spouse
False. When you marry, nothing in your credit reports and data changes automatically. If you and your spouse maintain completely separate credit accounts, everything will stay the same.
Now, what happens if you both apply for a joint credit account, such as a credit card, mortgage, or auto loan? The account will appear on both of your credit reports, and you’ll both be responsible for ensuring payment on the account, and appropriate debt levels (for a credit card). If your husband or wife is tasked with making monthly payments on the account, and forgets to do so, your credit score will suffer as well.
For this reason, you’ll want to make sure that you have clear arrangements in place, as to who is going to pay, and what each person’s responsibility here is. By doing so, as your relationship continues to grow, so will your credit, and ultimately, a positive financial future.
The Final Word
There are lots of false beliefs surrounding credit scores. It is important that you are educated on the truth, so that you can enjoy the best credit scores possible, allowing you to save money and live better.
