Understanding credit scores' intricacies often feels like deciphering an ancient code. Various myths and misconceptions surround this numerical measure, leading many people astray when it comes to improving their financial health.
However, knowing what influences your credit score is essential in making informed financial decisions. This article aims to debunk common credit score myths and provide clarity on the factors that genuinely affect it.
One of the most prevalent myths about credit scores is that checking your score will negatively impact it. This belief likely stems from misunderstanding the difference between "hard" and "soft" inquiries into your credit report.
A hard inquiry occurs when a lender or credit card company assesses your credit status as part of their decision-making procedure. Such inquiries may temporarily reduce your credit score and can be noted on your credit report for up to two years. Instances, where hard inquiries occur include when you apply for a mortgage, auto loan, or a fresh credit card.
Conversely, a soft inquiry occurs when you personally review your credit score or when an organization evaluates your credit for pre-approval reasons. These soft inquiries do not influence your credit score and remain undetectable to prospective lenders reviewing your credit report.
It's a common misconception that closing old or unused credit accounts can improve your credit score. Many people believe having fewer credit cards will make them appear less risky to lenders, but the opposite might be true.
A significant element affecting your credit score is your credit utilization rate, defined as the proportion of your entire credit card balances relative to your overall credit card limits. Shutting down an old account, particularly one that carries no balance, diminishes your available credit and may elevate your credit utilization rate. This could inflict damage on your credit score.
The duration of your credit history is another vital component of your credit score. Lenders prefer to observe a long-standing record of proficient credit management, and terminating an old account can truncate your credit history, especially if it's your most longstanding account.
One of the most pervasive myths about credit scores is that your income directly affects your score. This belief is misleading and can often lead to confusion about calculating credit scores.
Your earnings aren't communicated to credit bureaus, so they don't directly impact your credit score. The primary determinant of your credit score is your behavior concerning borrowing, not your income potential or wealth. The principal aspects influencing your credit score encompass your repayment track record, the amounts you owe, the duration of your credit history, the diversity of your credit types, and recent credit inquiries.
However, it's important to note that while income doesn't directly impact your credit score, it can indirectly influence it. For example, a higher income could enable you to more easily manage and promptly pay off your debts, which would positively impact your credit score. Conversely, if your income is lower and you struggle to meet debt payments, this could negatively affect your score.
Lenders may consider your income when deciding whether to extend credit to you, as it helps them determine your ability to repay a loan. While they want to see a good credit score, they also want to ensure that you have the means to handle the debt.
The idea that all debts are equally damaging to your credit score is a common misconception. Not all debts are created equal, and different types of debt can have varying impacts on your credit score.
There are generally two types of debt—installment loans and revolving credit. Installment loans, such as mortgages and auto loans, involve borrowing and repaying a fixed amount over a set period. Revolving credit, like credit cards, allows you to borrow up to a certain limit as needed and carry a balance from month to month.
Credit scoring models consider your mix of credit types. Having a variety of both installment loans and revolving credit can be beneficial for your credit score, showing lenders that you can handle different types of credit responsibly.
Moreover, high balances on revolving credit accounts can be particularly damaging to your credit score due to the impact on your credit utilization ratio, a key factor in credit score calculations. On the other hand, keeping up with installment loan payments can positively influence your payment history, another significant factor in your credit score.
It's important to note that debts in collections or defaulted loans can severely harm your credit score. These reflect poorly on your creditworthiness and ability to manage debt, and they can remain on your credit report for several years.
A common misconception about credit reports is that paying off a negative record, such as a late payment or collection account, automatically removes it from your report. This belief, unfortunately, is not accurate.
Paying off negative records, such as late payments or collections, doesn't immediately erase them from your credit report. These items can remain on your report for seven to ten years, reflecting your past debt management behavior to potential lenders.
However, settling these debts changes their status to "paid," which is more favorable and lessens their impact on your score over time. Moreover, your credit score can improve if you consistently exhibit good credit behavior after settling a negative record. Remember, you can dispute and potentially remove any inaccurate negative information on your credit report by contacting the credit bureau.
Grasping the elements that impact your credit score is essential for preserving or enhancing your fiscal well-being. Here are the key aspects that have a bearing on your credit score:
This factor is the most consequential, constituting around 35% of your FICO score. It encompasses prompt bill payments, credit card dues, loan repayments, and other debt obligations. Delinquent or overlooked payments can adversely affect your score.
This represents the debt you owe relative to your total accessible credit, contributing to almost 30% of your credit score. A diminished utilization ratio is more beneficial for your score.
The duration of time you've had credit accounts open, and the activity within those accounts, accounts for about 15% of your score. A longer credit history typically improves your score.
Your variety of credit types (credit cards, retail accounts, installment loans, mortgage loans, etc.) makes up about 10% of your score. A diverse mix of credit can be beneficial.
The number of recent inquiries or applications for credit accounts for the remaining 10% of your score. Multiple inquiries in a short span can lower your score.
And so, we pull back the curtain on the often mystifying world of credit scores. We've debunked myths, shattered misconceptions, and revealed the true titans that hold sway over your credit score. From understanding the difference between debt types to knowing what gets erased from your report, we've journeyed through the labyrinth of credit score myths.
Remember, knowledge is power—in this case, the power to improve your financial health and creditworthiness. So, step out of the shadows of myth and into the light of fact, and take control of your credit score today!
