Consumer credit scoring is commonly misunderstood, but it’s important to understand. Your credit score is a key consideration in loan applications and helps determine the interest rate you’ll pay on those loans. The lower the interest rates on your loans, the more income you’ll have available for retirement savings and other uses. So let’s shed some light on five common misconceptions.
“All credit scores are FICO scores.”
The most widely-used credit score model is FICO (Fair Isaac Corporation). Most lenders do use FICO, but you have three different FICO scores from the three major credit bureaus—Experian, TransUnion, and Equifax. Many lenders use their own credit scoring system, which often includes the FICO score as well as other information. A good place to learn more about credit scoring in general is www.myfico.com.
“Carrying a big balance helps my credit score.”
Not so. It’s true that a history of good debt management gains you a higher score than having no debt at all, but the less outstanding credit you have, especially on credit cards, the better. And paying on time is critical. In fact, if you run up an especially-big credit card bill in any given month, try to pay it off a few days early, because outstanding debt is reported to the credit bureaus at the end of the month.
“Wiping out a delinquent debt will immediately fix my score.”
Unfortunately, negative information on your credit report is slow to disappear—seven years for credit delinquencies and ten years for bankruptcy information. It’s far better to avoid credit trouble in the first place.
“I should close my accounts as I pay each one off.”
Closing accounts can actually hurt your score, because credit bureaus look at your “utilization ratio” of credit used vs. credit available. A closed account has zero dollars available, so it’s better to keep your accounts open and only charge (then pay off) one or two small amounts each year. Another reason to keep accounts open is that your score considers both the average age of all your accounts and the age of the oldest one. If you do want to eliminate a line of credit, call or write the lender to ask that your account be closed “at the cardholder’s request,” with written confirmation.
“I only use cash so my score must be great.”
Unfortunately, no. You must use credit to build credit and demonstrate that you pay your debts. Living on cash only doesn’t establish a payment history, and that could be a problem when you want to buy a house or car.
This One’s No Myth
To maintain a good credit score, pay your bills on time, keep your total debt low in proportion to your available credit, and review your credit report regularly to look for errors. Also remember that it’s not only the number of your credit score that’s important, but also the information contained in your report. Be sure to review your credit report from all three reporting agencies annually at AnnualCreditReport.com.