Information found at www.cheatsheet.com
How much do you really know about credit scores? Though your credit score affects everything from your ability to rent an apartment to how much you’ll pay every month on your car loan, many people aren’t sure how scores are calculated, don’t know what the scores are used for, and believe common credit score lies and myths that cause them to make dumb money decisions. So what’s the truth behind this all-important number?
“Your credit score plays a pivotal role in your financial journey. As far as numbers go, it’s one of the most important that will ever be attached to your name,” Julie Pukas, head of U.S. bankcard and merchant services at TD Bank, told The Cheat Sheet.
The majority of people understand that mortgage lenders and credit card companies use credit scores when making lending decisions, a recent survey by the Consumer Federation of America (CFA) and VantageScore found. Most also know that declaring bankruptcy or making late payments will hurt your score. But beyond those basics, misinformation and credit score lies abound. Only 25% of people surveyed by the CFA were aware that a low credit score could increase the cost of a car loan by $5,000, and more than half didn’t realize landlords, utility companies, cellphone companies, and insurers sometimes check credit scores.
“Many people scorn credit, but the simple fact of the matter is that in most situations, your credit score is a deciding factor in whether you’ll be approved for a mortgage, car loan, credit card, or another type of loan,” Pukas said. “If you’re looking for an apartment, your score may impact your probability of getting approved, the size of your security deposit, and how much you pay in fees. It can also impact how much you pay for home and auto insurance and might even decide whether you’re approved for a new cell phone plan.”
Being misinformed about credit scores or believing credit score myths can have serious financial consequences, whether you’re a borrower or not. You can boost your credit savvy by familiarizing yourself with the truth behind these seven big credit score lies.
1. Checking your own credit will lower your score
Requesting a copy of your credit report or pulling your own score won’t hurt your credit rating, contrary to popular belief. “This widespread credit misconception fools a lot of people,” Pukas said. The myth arises from confusion about the difference between “hard” and “soft” credit inquiries.
Soft inquiries happen when someone who is not a lender pulls your credit report, and they aren’t factored into your credit score. When you check your own score or a prospective employer reviews your credit history, it’s a soft inquiry. Hard inquires are the result of someone pulling your score after you request a loan or apply for an apartment, and they can lower your score. But looking around for the best deal on a loan or credit card won’t necessarily hurt your score.
“If you’re shopping for a loan and concerned about harm to your score, know that multiple loan inquiries within a period of a few weeks are usually treated as a single inquiry to minimize impact,” Pukas said.
2. Co-signing for a loan won’t affect your credit score
Co-signing for a loan makes you responsible for it, a fact many people discover only after the fact. Once you’ve agreed to guarantee someone’s debt, you will be on the hook to make the lender whole if the other borrower fails to make payments. Plus, if the person you co-signed is financially irresponsible, it could lower your own credit score.
“If you open an account jointly or co-sign a loan, you will be held legally responsible for the account. Activity on the joint account is displayed on the credit reports of both account holders,” Pukas said. “If you co-sign for a friend’s auto loan and that person doesn’t make the payments, your credit profile will be hurt and vice versa. The only way to end the dual liability is to have one party refinance the loan, or persuade the creditor to formally take you off the account.”
3. Paying off old debt will raise your credit score by 50 points
Paying off an old debt may boost your credit score, but there’s no way to say by how much. Each credit scoring agency uses proprietary formulas to calculate your score, which makes it difficult to say exactly how much a given action – such as repaying a years-old loan – will affect your score.
“Credit reporting agencies calculate your credit score via a complex algorithm that uses hundreds of factors and values,” Pukas said. “It’s almost impossible to calculate the exact difference in points changing one factor might make.” Instead, practice good financial habits to boost your score and keep it high. “A proven record of sound financial behavior and time will have the most significant impact on your score,” Pukas said.
4. All credit scores are the same
Did you know you have dozens of different credit scores? Most people assume their credit score is a single three-digit number, but each of the three major credit bureaus (Experian, Equifax, and TransUnion) scores you differently, since they don’t necessarily have the exact same data in their files. Plus, each agency has different scores for different types of loans, including car loans, mortgages, and credit cards.
The three big credit bureaus also produce the VantageScore, a FICO score competitor. Because it uses a different formula to calculate scores, VantageScore claims it is able to rate more people than FICO.
5. You should close old accounts to raise your score
If you have store charge cards you opened in college or a high-interest credit card you haven’t used in years, cleaning up your finances by closing a few accounts might seem like a good idea. You might even assume making this financially responsible move would boost your score. But in reality, your effort to keep your finances in order could backfire.
“[One] credit myth advocates closing old and inactive accounts to hike up your score,” Pukas said. “However, this might inadvertently have the opposite affect [sic] and lower your credit score because now the credit history appears shorter.” If you want to simplify your finances, close newer credit accounts first, Pukas said, or squirrel your card away somewhere (some people suggest freezing it in a block of ice) so you can’t use it but your credit history stays intact.
6. Paying off a bad debt erases it from your credit report
You can’t make your past financial mistakes disappear. Once a debt goes to collections or you’ve established a history of late payments, you will have to deal with the consequences, even if you pay off what you owe.
“Generally, negative records, such as collection accounts and late payments, will remain on your credit reports for up to seven years from the date of first delinquency,” Pukas said. “Paying off the account sooner doesn’t mean it’s deleted from your credit report; instead it’s listed as ‘paid.’”
“Of course, it’s smart to pay your debts, both to reduce the total amount of debt you owe and to show your willingness to repay your obligations,” Pukas added. “But expect the negative record to have some effect until it is purged from your report.”
7. Your age, marital status, and race affect your credit score
Roughly two-fifths of people believe factors like their age and marital status affect their credit score, according to the CFA survey. Twelve percent of people mistakenly believed that race or ethnic origin was used to calculate credit scores.
While factors like age or marital status might have an indirect effect on your credit (younger people will usually have a shorter credit history than someone who is older, for example), neither is specifically factored into your score. The same goes for race. In fact, credit scoring agencies are prohibited from taking race, gender, marital status, religion and similar factors into account when developing scores, according to the Equal Credit Opportunity Act.