What Truly Matters When It Comes to Your Credit?

Credit scores are an unavoidable part of our lives. They can work in your favor or dampen your chances of financing your dream home. You may find yourself wondering if you will qualify for your next auto loan or be denied when applying for a retail credit card. Rather than living in doubt about how your credit stacks up, learn how to manage your credit worthiness by understanding the common myths surrounding credit scores and credit reports.

What Is Credit and Why Is It Important?

Credit is a financial arrangement where a lender allows you to borrow money with the agreement that it will be repaid later. The decision to extend your credit depends on your credit score, which is linked to your Social Security number. Credit scores represent how well you have managed your credit over time and if you have successfully repaid borrowed money. A higher credit score shows you have a history of paying debts on time and in full. In contrast, a lower credit score confirms you have been inconsistent or late in making your debt payments.

The popular credit scoring system, developed by the Fair Isaac Corporation, is referred to as the FICO® score. Lenders use this three-digit credit score to evaluate your creditworthiness, establish an interest rate, and determine the amount of funds they are willing to lend to you. The higher your score, the more likely you are to receive the credit approval you are seeking.

Credit scores generally range from 300 to 850 and fall within categories of poor, fair, good, very good, or excellent. Scores of 670 and higher are often considered a good score and represent a lower credit risk to a lender. Poor scores are typically around 600 or less and may have a more difficult time being approved for credit.

While FICO provides a single credit score, credit bureaus provide a score plus a detailed credit report. The three major credit bureaus– Equifax®, Experian®, and TransUnion®–collect data on borrowing habits to create these reports. Even though your credit score is usually determined based upon five components including payment history, amount owed, credit history, type of credit, and new credit inquiries, each bureau has developed its own model to evaluate your credit. This means your scores may vary from one credit bureau to another.

7 Common Credit Card and Credit Score Myths

Understanding how credit scores and credit reports are determined is an important part of being a savvy borrower, but so is the ability to weed through the mass amounts of misleading information. Differentiating myths from facts when it comes to your credit will be your key to success.

Myth #1: Debt Is Bad

Many feel the need to be completely debt-free. That may be an important goal for a variety of reasons, but it is also important to understand that responsible borrowing can help improve your overall financial health. If you commit to only borrowing within your means and following through on repayment, the result can be a solid credit history and a strong credit score. Even if you believe you won’t need to borrow funds in the future, your circumstances can change quickly. When that need arises, a history of responsibly handling your credit will put you in the best possible borrowing situation in the future.

Myth #2: Poor Financial Decisions Ruin Credit Forever

Financial behaviors from your past can haunt your credit score, but you do have room for improvement. Two of the most important ways to rebuild your credit is to pay down the total amount you owe and to consistently make payments on time. Improving your credit score takes a while, but the negative items will have less impact over time. A delinquent debt will be removed from your credit report seven years after it was first considered unpaid. Even though this bad debt will still appear on your report during this time, you should still pay it off. An account that is shown as paid in full is still better than an account that continues with an unpaid balance.

Myth #3: You Have to Have a High Income to Have a High Credit Score

Higher salaries do not equate to higher credit scores. Your credit score is calculated on your credit history, not your income. What matters is whether you have a history of paying your bills on time and that you haven’t overextended your credit with an excessive amount of debt. However, in addition to your credit score, a lender may consider your income when evaluating your ability to repay a loan. A higher income could demonstrate a larger capacity to pay multiple debts.

Myth #4: Demographic Information Impacts Credit Scores

Not only are gender, race, nationality and marital status not included when calculating credit scores, the Equal Credit Opportunity Act (ECOA) does not allow demographic information to be considered by lenders. The scoring system is designed to provide an objective assessment of an individual’s credit worthiness by removing any factors that could lead to discriminatory practices. The focus remains on your credit history and how consistently you pay your bills on time.

Myth #5: You Should Keep a Credit Card Balance to Improve Credit Scores

Carrying a credit card balance can, in fact, harm your credit score because it increases your credit utilization. Credit utilization measures the amount of the credit limit that you have in use. If your credit balance represents a large amount of your available credit, your credit score could be impacted significantly. Credit card balances also lead to high interest costs due to the double-digit interest rates that are often attached to credit cards. Paying your credit card balance in full before the due date each month may lead to both lower monthly expenses and improved credit utilization ratings.

Myth #6: You Should Close Credit Cards to Increase Credit Score

If you are considering closing a credit card you no longer use, think again. While there are reasons you may want to close a credit card such as high annual fees or poor customer service, first consider the impact it will have on your credit score. When you cancel or close a credit card, you affect the length of your credit history and increase your credit utilization rate. These are both factors that largely affect the strength of your credit score.

Myth #7: Your Credit Score Will Decrease If You Check It

Credit checks come in two forms: soft inquiries and hard inquiries. Checking your own credit, for instance, is considered a soft inquiry and does not affect your credit score. Hard inquiries, such as when a lender pulls your credit report, can lower your score. However, some exceptions exist. Multiple inquiries within a short period of time for auto loan or mortgage rate shopping will only count as one hard inquiry. This allows you to shop multiple lenders for the most favorable terms. Yet, applying for several credit cards at once will result in multiple hard inquiries on your credit report.

 

Keep Your Credit Goals on Track

In addition to debunking these credit score and credit card myths, regularly review your personal credit reports. Did you know that you can request a free copy of your credit report once each year? Be sure to request one from each of the three major credit bureaus. This is important because lenders will use any one or more of these reports to determine your credit worthiness. If you find any discrepancies or mistakes, address them immediately by contacting each of the credit-reporting agencies. When each of your credit reports are error-free and you show an on-time payment history, you’ll be putting your best financial foot forward regardless of which credit bureau’s report is pulled. It also pays to be patient, because building good credit requires time. It may take six months to a year or two of positive credit history to notice an improvement. But stay the course. Using debt wisely, paying bills on time, every time, and living within your means are all financial behaviors that will position you well for future borrowing needs.