You might think your credit reports and three-digit credit scores are simply tools lenders use to decide whether you’ll get that new mortgage or credit card. And that’s partly true. But your credit history and credit score also provide lenders a glimpse of your past spending habits, including how well you manage expenses.
Keeping tabs on all this can go a long way toward helping you take control of your financial life. Yet, it’s essential to separate the facts from fiction. Here are five myths about credit and the truths behind them.
Myth 1: Lenders Use Only One Credit Score
Fair Isaac Corporation (FICO) and VantageScore are examples of credit-scoring models in use today. Each considers different factors when determining a credit score between 300 and 850; however, payment history and credit utilization are highly influential for both. There are also multiple versions of the models, which are updated frequently.
The information in your credit reports may differ at the three largest credit bureaus, Equifax, Experian, and TransUnion. Additionally, the credit score your lender is using may not be the same as what you find on personal finance websites or from free credit-monitoring services. Most mortgage lenders use some version of the FICO Score in lending decisions.
Myth 2: All Debt Is Considered Equal
Credit-scoring models don’t consider installment loans, like student loan debt, mortgages, and auto loans, in the same manner as revolving credit, such as credit card debt. Depending on the scoring model, the percentage of your available revolving credit that you use may impact your credit score more than your timely fixed payments on installment loans.
Of course, making on-time payments for both installment loans and credit cards each month is crucial. Your payment history is one of the most important criteria when calculating credit scores at Equifax, Experian, and TransUnion, based on the credit models developed by FICO and VantageScore.
Myth 3: Closing Accounts Will Improve Credit
Scoring models pay close attention to your credit utilization ratio—the amount of revolving credit you’re using in comparison to the total amount of credit available. And after your payment history, this calculation is one of the most significant factors the scoring models consider. Therefore, closing an account could potentially lower your credit score.
If, for example, you have $10,000 in available credit on all of your credit card accounts and have a collective balance of $3,000, your credit utilization ratio is 30%. But if you close a credit card account that has a $5,000 credit limit (leaving you with $5,000 in available credit) and your outstanding balances remain at $3,000, then your credit utilization ratio will skyrocket to 60%.
In general, using a high percentage of available credit can hurt your score since it indicates you’re close to maxing out your available credit. On the flip side, a low percentage of use can have a positive effect. There may be times when low credit utilization will have a more positive impact than not using any available credit at all.
Based on the behavior analysis of millions of consumers, the risk of default may be higher for someone with a 0% utilization ratio than for someone with a slightly higher-than-0% utilization, according to Barry Paperno, a former manager with FICO and Experian. “The main reason for this odd occurrence is that a $0 balance—which leads to 0% utilization—is often the result of not using credit regularly, which research has shown to indicate higher future risk,” Paperno wrote in a February 2020 “Speaking of Credit” blog post on CreditCards.com.
The takeaway? Consider lowering your overall debt utilization as a way to boost your credit score.
Myth 4: Loan Shopping Will Hurt My Score
During the application process for a new line of credit, a lender will request your credit score from a credit bureau to evaluate your financial history and how much risk you pose as a borrower. This lender’s request to look at your credit file may be considered a “hard inquiry.”
Typically, hard inquiries are noted on your credit report for up to two years and can negatively affect your score for the first 12 months after the credit pull. Credit scoring models aren’t just about raw data, though. The formulas consider a specific pattern of multiple credit inquiries a sign of typical consumer behavior when shopping for home loans. Hence, multiple inquiries bunched together within a 45-day window may only count as one hard inquiry in the FICO and VantageScore credit models.
What’s more, not all credit pulls impact your score. One such type is called a "soft inquiry" or "soft credit pull," and is not associated with a specific application for credit. Another type of credit pull that does not affect your credit score is the one you initiate yourself. Federal law grants you a free copy of your credit report annually. You can get your reports online via AnnualCreditReport.com, a joint-venture website set up by the three main credit bureaus.
Myth 5: DIY Credit Repair Doesn’t Work
Some individuals consider using credit repair companies to assist with raising their scores. These companies often charge a fee to perform activities, such as disputing inaccurate information in a credit report.
When it comes down to it, you have the most control over fixing your financial situation and boosting your credit score. There's a system in place to help you maintain accurate credit files and plenty of credible DIY credit repair advice on the internet to guide the way. Suppose you have been denied credit, insurance, or employment, based upon your credit report. Any adverse action like this entitles you to a free credit report to verify your credit file's content. It doesn't cost anything to dispute incorrect or outdated information on file at the credit bureaus and request an investigation. Both the credit reporting companies and the information providers are responsible for correcting and updating the data in your report. But the onus is on you to point out the issues first to get the ball rolling. To assist, Fair Isaac Corporation has provided a summary of how to dispute inaccurate information with each of the three credit bureaus.
It takes time to improve your credit, and you can legitimately do it yourself. Opening accounts that report to the credit bureaus (but limiting how often you submit credit applications), maintaining low balances, catching up on past-due accounts, and then paying your bills on time play a significant role in raising credit scores. It all comes down to displaying responsible financial behavior, according to the current FICO and VantageScore credit models. So, take the challenge and learn to take charge of your credit like a pro. Creditworthiness is within your reach!
