Credit scores play a crucial role in personal finance, impacting everything from loan approvals to interest rates and even job prospects. Despite their importance, many people harbor misconceptions about how credit scores work. These myths can lead to poor financial decisions that hurt your credit score and overall financial health. In the following article, Michael L. Niemczyk debunks some of the most common myths about credit scores and provide accurate information to help you better manage your financial health.
Myth 1: Checking Your Own Credit Report Lowers Your Score
One of the most pervasive myths is that checking your own credit report will negatively impact your credit score. This confusion often arises from misunderstandings about hard and soft inquiries.
Reality: Checking your own credit report is considered a soft inquiry and does not affect your credit score. In contrast, hard inquiries, which occur when lenders check your credit for loan approvals, can impact your score slightly. Regularly monitoring your credit report is a good practice, as it helps you stay informed about your credit status and identify any errors or fraudulent activities early on.
Myth 2: Closing Old Accounts Always Helps Your Credit Score
Many people believe that closing old or unused credit accounts will improve their credit score. While this might seem logical, it’s not necessarily true.
Reality: Closing old accounts can actually hurt your credit score. Credit scores are partly based on your credit utilization ratio, which is the amount of credit you’re using relative to your total available credit. Closing an old account reduces your total available credit, potentially increasing your credit utilization ratio and lowering your score. Additionally, the length of your credit history accounts for 15% of your score, so closing older accounts can shorten your credit history and negatively impact your score.
Myth 3: Carrying a Balance on Your Credit Card Improves Your Score
Some believe that carrying a balance on credit cards and paying interest will boost their credit score. This misconception can lead to unnecessary interest payments and financial strain.
Reality: Carrying a balance does not improve your credit score. What matters is that you consistently make on-time payments and keep your credit utilization low. Paying off your balance in full each month demonstrates responsible credit behavior and avoids interest charges, benefiting both your credit score and financial health.
Myth 4: Your Income Affects Your Credit Score
Another common myth is that your income is a factor in determining your credit score. While income is important for lenders to assess your ability to repay loans, it doesn’t directly impact your credit score.
Reality: Your credit score is based on your credit history, including payment history, credit utilization, length of credit history, types of credit, and recent inquiries. Income is not included in the calculation. However, lenders do consider your income when deciding whether to approve a loan or credit application, as it helps them determine your repayment capacity.
Myth 5: Only One Credit Score Matters
Many people assume there’s just one credit score that lenders use to evaluate creditworthiness. This oversimplification can lead to misunderstandings when different scores are presented.
Reality: There are multiple credit scoring models, the most common being FICO and VantageScore, and each can generate different scores. Additionally, each of the three major credit bureaus (Equifax, Experian, and TransUnion) may have slightly different information on file, leading to variations in your credit scores. It’s important to monitor all three reports to get a comprehensive view of your credit health.
Myth 6: Bankruptcy Ruins Your Credit Forever
Filing for bankruptcy is a serious financial decision, but the belief that it permanently destroys your credit is a myth.
Reality: While bankruptcy significantly impacts your credit score and remains on your credit report for up to 10 years, its effects diminish over time. With responsible financial behavior, such as making timely payments and keeping balances low, you can begin rebuilding your credit relatively quickly. Many people start to see improvements in their credit score within a few years after bankruptcy.
Myth 7: Using a Credit Repair Service is the Only Way to Fix Your Credit
Credit repair services often promise to improve your credit score quickly, leading some to believe this is the only way to fix credit issues.
Reality: While legitimate credit repair services can assist in disputing errors on your credit report, you can often do this yourself for free. By regularly checking your credit report, disputing inaccuracies, making on-time payments, and reducing debt, you can improve your credit score without incurring the cost of credit repair services.
Conclusion
Understanding the realities behind common credit score myths is essential for managing your financial health effectively. By dispelling these misconceptions, you can make informed decisions that positively impact your credit score and overall financial stability. Regularly monitoring your credit report, maintaining low credit utilization, making timely payments, and educating yourself about credit can help you achieve and maintain a healthy credit profile.