Credit Scores – 5 Common Myths
Your credit score is an integral part of your financial life. It is important that you understand what it’s all about. Lenders, landlords, insurers, utility companies and even employers look at your credit score. It is derived from what’s in your credit reports, and it ranges between 300 and 850. Unfortunately, people commonly have a lot of misinformation and misunderstandings about their credit score. Here are five of the most common credit score myths and along with it the true facts.
Nearly half of all Americans don’t know how these scores are derived or even what factors are used to come up with them.
For example, if your credit score is 580 you are probably going to pay nearly three percentage points more in mortgage interest than someone who had a score of 720. Consider this example: if you had a $150,000 30-year fixed-rate mortgage and your credit score was good enough to qualify for the best rate, your monthly payments would be about $890. This is according to Fair Isaac, the company that created the FICO score and who the rate is named after (Fair Isaac Corporation). If your credit is poor, however, it is very likely that you would have to pay more than $1,200 a month for that same loan.
With so much depending on the credit score, it’s important to understand what it is and what things that affect it.
Common MYTH #1: The major bureaus use different formulas for calculating your credit score
FACT: The three major credit bureaus – Equifax, TransUnion and Experian — give the score a different name. Equifax calls their score the “Beacon” credit score. Transunion uses “Empirica”. Lastly, Experian gives it the name “Experian/Fair Isaac Risk Model.” They all use different names for the credit score, but they all use the same formula to come up with it.
The reason the credit score you receive from each bureau is different is because the information in your file that they base the score on is different. For example the records that one bureau is using may go back a longer period of time, or a previous lender may have shared its information with only one of the bureaus and not the other two.
Usually the scores are not too far from each other. Unless there is a big difference between what each bureau says is your credit score, many lenders will just use the one in the middle for the purpose of analyzing your application. It is a good idea to correct any errors that exist in each of the three major credit bureaus.
Common Myth #2: Paying off your debts is all you need to do to immediately repair your credit score
FACT: Your credit score is mostly determined by your past performance more than your current amount of debt. It is always helpful to pay off your credit cards and settle any outstanding loans. If yours is a history of late or missed payments, it won’t remove the damage overnight. It takes time to repair your credit score.
So definitely pay down your debts, but be consistent with paying your bills on time.
Common Myth #3: Closing old accounts will boost my credit score
FACT: This is a common misconception. It’s not closing accounts that affects your credit score, it’s opening them. Closing accounts can never help your credit score, and may actually hurt it. Yes, having too many open accounts does hurt your score. But once the accounts have been opened,the damage has already been done. Shutting the account doesn’t repair it and it may actually make things worse.
The credit score is affected by the difference between the credit that is available and the credit that is being used. Shutting down accounts reduces the amount of total credit available. This can make your debt seem larger and this hurts your credit score.
The credit score also looks at the length of your credit history. Shutting older accounts removes old history and can make your credit history look younger than it actually is. This also can hurt your score.
You generally shouldn’t close accounts unless a lender specifically asks you to do so as a condition for them giving you a loan. Instead,the best thing you can do is just pay down your existing credit card debt. That’s something that definitely would improve your credit score.
Common Myth #4: Shopping around for a loan will hurt my credit score
FACT: When a lender makes an inquiry about your credit, your score could drop up to five points. Some borrowers think if they shop around by between lenders, each inquiry will generate another reduction in the credit score. This isn’t true. For credit score purposes, multiple inquiries for a loan are treated as a single inquiry, as long as they all come within a 45 days. So it is best to do your rate shopping within this 45 day window.
Common Myth #5: Companies can fix my credit score for a fee
FACT: If the credit bureaus have accurate information, there’s nothing that can be done to quickly improve your score if in fact you have a history of not handling your debts well. The only way to have an effect on your credit score is to show that you can manage your debts in the future.
Also,if there are errors in your file, you can contact the bureau yourself. You don’t need to pay someone else to do it. Each of the major credit bureaus has a website which clearly explains what you need to do to correct an error.
The best ways to improve your credit score are: pay down the debt, pay your bills on time, correct existing errors on your credit reports in each of the three bureaus and apply for credit infrequently.