NEW YORK (MainStreet) — The tabulation of credit scores is complicated, because each of the three credit bureaus uses its own formula, but consumers commonly misunderstand many facts about paying bills and credit cards.
Below MainStreet has compiled the ten largest misconceptions consumers have about their credit scores. A high credit score allows consumers to pay a lower interest rate for credit cards, mortgages and auto loans and also gives them lower rates for auto and home insurance. Here’s a quick rundown of what the numbers mean – a score of anything below 620 ranks as poor, 620-699 is fair, 700-749 is good and anything over 750 is excellent.
First Myth: Closing old or inactive credit cards will boost my credit score.
Reality: The length of your credit history affects 15% of your score. This is why it's important not to close credit card accounts that you have had for years. Keep them open, use them sparingly and pay the balance off every month, said Jason van den Brand, CEO of Lenda, a San Francisco-based online home mortgage service.
Second Myth: Most problems on credit reports are errors occurring in the amounts that are owed or paid off.
Reality: Inaccuracies in all types of information on credit reports can affect credit scores more than most people might think, said Kevin Gallegos, vice president of the Phoenix operations for Freedom Financial Network, a consumer debt resolution company. It is important to check identifying information, even basic statistics such as your name, address, date of birth, Social Security number and "aliases," such as names with or without a middle initial and maiden names.
Third Myth: Paying off prior debt like a credit card or medical bill will help increase my credit score.
Reality: Even paid-off off prior debt that has surpassed the seven year mark, which is when they no longer appear on your credit report, will lower your credit score, said Bruce McClary, spokesman for National Foundation for Credit Counseling, a Washington, D.C.-based non-profit organization. Whether you are paying the entire amount of the debt or just making a payment, it creates activity on your credit history, causing it to resurface. “It will bring down your credit score,” he said. “Even if you make one lump payment, it restarts the clock on negative activity reported to your credit history. Lenders consider this as new debt.”
Fourth Myth: Missing one payment on my credit card is no big deal since I have never missed one before.
Reality: If you miss even one payment on your credit card, it can cause your credit score to drop by 100 to 300 points, said McClary. The larger the balance is on your card, the more effect it has on your credit score. This misstep means it can take consumers a long time to “climb out of the hole.” It could even take as long as two years to restore your credit score to its previous level. The first rule of thumb is to pay your bills on time since that factor makes up 35% of your score.
Reality: Each spouse has his own credit score, based on the accounts in his name, even if spouses share the same last name. Each person needs to obtain his own credit reports, review for accuracy regularly and correct errors on his own credit report, said Gallegos.
Sixth Myth: If one spouse has a better credit score than the other, any joint accounts they hold will bring down the score of the spouse with the better one.
Reality: If one spouse has an account in good standing with a good history, adding a credit score-challenged spouse as a joint account holder actually will help the latter’s score, said Gallegos. The score of the spouse with the better score will not be negatively affected by having the other person on the account.
Seventh Myth: Employers don’t really check credit reports before hiring someone. It’s illegal.
Reality: They do indeed and can unless the state you live in limits it to only people in certain professions. The most common reason is to check an applicant’s financial stability and debts, said Gallegos. Most employers who want to check on this information are those hiring for positions in management or those that require access to large amounts of money or sensitive information, such as banks and other financial institutions.
Eighth Myth: It does not matter how much I charge on my credit cards, because I have several of them.
Reality: Decrease your credit card debt, because the amount you owe makes up 30% of your score. Your credit utilization rate should be under 30% also. “Your goal should be to get this as low as possible,” said van den Brand. “If you're carrying balances on credit cards that exceed 50% of the available credit then you're hurting your credit score,” he said. “Strive to get your total credit utilization under 50% first and then keep going.” This is one of the fastest ways to increase your credit score."
Reality: Trying to open new credit accounts all at one time can hurt your credit score. Any new credit makes up 10% of your score, so don’t open up a bunch of credit card accounts in a short period of time even to receive a store discount for your purchases. Lenders view this as a consumer having the potential of a “borrowing binge,” said McClary. There is a possibility a person could max all of them out in no time at all, he said. Too many inquires also lower your score.
Tenth Myth: Using cash, debit cards and pre-paid cards is just the same as someone who pays for bills with a credit card.
Reality: The type of credit you have also affects 10% of your score. You want to show that you can manage a mix of different types of lines of credit such as credit cards, auto loans and mortgages. While using cash is an effective way to manage your debt, lenders like to see a pattern of a consumer being able to pay their debt on-time each month, said McClary. Not having a credit history affects you when you go to buy a car or apply for a mortgage. “You never know when having a good credit history is going to come in handy when you have to finance something,” he said.
--Written by Ellen Chang for MainStreet