Like it or not, credit scores play a major role in your financial life...and not just when it comes to loans. Landlords may use them to decide who gets to rent their apartments. Credit scores are used by insurance to set premiums for auto and homeowners coverage. Some companies may not even hire someone with a low score. Credit scores can even determine what cell phone plan you get and the deposit amount for utilities. And of course, a bad credit score can cost you tens of thousands of dollars in interest on home, personal and auto loans.
There are a lot of misconceptions about credit scores, some which can ultimately hurt your score. Since this number is so vital, it’s important that everyone fully understands how credit scores work. Credit Card Insider recently conducted a survey to see which myths and misconceptions adults believe about credit scores.
Myth 1: My Income Impacts My Credit Score.
Nearly 2/3rds of survey respondents believe income impacts credit scores.
This is understandable - the more money you make, the higher your credit score, right? In actuality, your income does not directly affect your credit score. FICO scores are calculated using many different pieces of credit data grouped into five categories: payment history (35%), amounts owed (30%), length of credit history (15%), new credit (10%) and credit mix (10%). Your income is never included on credit reports.
Income does matter for credit cards and loan applications. Lenders approve loans based on several factors, including your earningsandyour credit score, but they are two separate pieces.
MORE FOR YOU
Income can also come into play withnew credit scoring models such as UltraFICO, which allows you to voluntarily submit information — including your income — for FICO to consider when calculating your UltraFICO scores.
Myth 2: Debit Cards Can Help Credit Scores.
42% of people think that debit cards can build credit history or help credit scores.
Nope. Debit cards don’t affect credit history and have no impact on your credit scores. Using your debit card is essentially the same as using cash. Even if you select “credit” at checkout - this just determines how the merchant processes the card, and what fees it pays.
Myth 3: Applying For New Credit Cards Can’t Hurt Your Credit Score.
27% of respondents said that applying for a new credit card can’t hurt your credit scores.
This can actually hurt your score in multiple ways. When you apply for a new credit account, such as a credit card, mortgage, or cell phone contract, a lender usuallyperforms a hard inquiry to check your credit. This is a part of normal process when applying for new accounts and 1-2 credit inquiries within 12 months won’t impact credit scores very much or for very long. However, if you have several hard inquiries within a relatively brief period of time, it can cause problems because it may look to lenders as if the borrow is desperate for a loan.
Keep in mind that if the bank approves your credit card application, a new credit card may also hurt your credit score. Your score may be dinged based on how long it's been since you opened a new account, length of credit history and the number of accounts.
Myth 4: Closing Credit Card Is Good For Your Score.
Almost 30% said that closing a credit card is good for your credit score.
In reality,closing credit cards can hurt, not help build, credit scores. The main issue is it reduces your amount of available credit. Credit utilizationis the ratio of your outstanding credit card balances to your credit card limits. It measures the amount of available credit that you are using - the lower the ratio, the better.
Consider this example. You have two credit cards, each with a $10,000 credit limit, for a total of $20K credit limit. You have $5000 on one card, and the other has a zero balance. Your current total credit utilization is 25% ($5000/$20,000), which is considered positive for your score. If you close the zero balance card, your credit limit is reduced to $10,000 so your utilization jumps to 50% ($5000/$10,000) - now hurting your credit score.
Closing cards also affects thelength of your credit history - how long your accounts have been open. Closing old credit cards that you’ve had for a long time will shorten the average age of your accounts, which reduces your credit score as well.
More on this is my recent article: How Closing a Credit Card Can Hurt Your Credit Score.
Myth 5: My Credit Score Will Be Good If I Don’t Have Any Credit Card Debt.
Almost a quarter (24%) of respondents said that their credit scores will be good as long as they don’t have any credit card debt.
This one just seems totally backwards. We constantly preach the dangers of credit card debt, but how are you rewarded when you have none? You get punished.
Unfortunately, establishing a positive credit history is virtually impossible without consistent, on-time payments. Without open, active accounts on your credit report, you won't even have a credit score. If you have an auto, student or mortgage loan with a solid payment history you can still have a good score without a credit card, but establishing and building a good credit history is easier if you have a credit card.
Plus as shown, your credit mix is 10% of your score. Having a diverse mix of credit, such as credit cards, auto loans, and/or mortgages helps your score.
What to do?
Looking at this list, it seems impossible to get it right. Don’t open any new credit card accounts, but you must have credit cards to get a good score. Don’t have too many accounts, but don’t close any either.
They don’t make it easy, but here are a few tips to help increase your score:
-Pay your bills on time.
-Pay off debt and/or keep balances low.
-Don’t close old credit cards.
-Check your score regularly, and report any inaccuracies. Consider using a credit monitoring service.
-Don’t apply for too much new credit in a short period of time.
Related: Consumers’ Knowledge About Credit Scores Is Down, But Actual Scores Are Up
