Last week I had discussed how you can and should access your credit history report for free to verify there are no errors. Your credit score plays an integral part in whether you are approved for either a mortgage, credit card and other loans. FICO is the score developed by Fair Isaac ranging from 300-850 (the newly rolled out FICO still uses the same range) which determines the likelihood if the borrower will default on the loan.
Your FICO credit score is based on the following:
10% – recently obtained credit or requests for credit
10% – the types of credit (revolving, fixed, mortgage)
15% – length of credit history (time is on your side!)
30% – amount of debt; ratio of credit balances to the total of available credit
35% – payment history (any payments past due later than 30 days)
It takes a long time to gain a solid FICO credit score and only one mistake to ruin it. I have several credit cards, a student loan and a car loan on my credit history report. So far I have no chinks in my report and have an above average credit score. We are looking to buy a house in the near future and we want to have the best credit possible to get the best rate on our mortgage. So what should we watch out for? Here are 8 credit myths that can affect your FICO score.
The Big Ones
MYTH 1. Closing old credit card accounts will improve your FICO score.
Having too many open revolving accounts (the 10% where there are hard hits for credit checks on your report) will do more harm than good. It is common to see people start to sign up for many credit cards to try and build there credit score quickly, however, that rush of credit card openings to try and raise your score will not do the job.
What’s wrong with closing those old accounts? This answer is actually two fold. FICO scores are calculated based on the average length of open credit accounts. If you close an older credit card, the average history length now decreases (the 15% length of history). If you close any credit card, your debt ratio will now increase (30% debt ratio). So canceling a credit card would actually affect 45% of how your score is calculated.
Note: credit card companies will often cancel your card if you are inactive. Be sure to make periodic charges to ensure your account is not closed. Many times you will receive a written notice before they do this. Try to avoid any credit cards that try to charge you will erroneous inactive or annual fees.
MYTH 2. Not having credit cards will increase your FICO score.
Credit cards are revolving credit which falls in the 10% types of credit and even partly the 30% of ratio of debt. While not having credit cards doesn’t hurt your score, it doesn’t really do it any favors. Credit cards are the easiest way to also build credit history. Having a credit card doesn’t mean you have to carry a balance or max it out. It just shows that you are responsible in paying back debt.
For people who are looking to get good rates on loans, I believe that having at least one credit card is essential. But with anything, use in moderation and never live above your means. Don’t forget, there is also the 35% payment history, so as long as you make a charge here and there and pay it off…a better credit score!
MYTH 3. Having higher credit limits lower your FICO score.
Having high credit limits is actually a good thing as long as you aren’t maxing out the credit card. This again is a part of the 30% debt/credit ratio. Let’s say you have 3 credit cards with credit limits of $5,000, $8,000 and $10,000 for a total credit of $23,000. Let’s say you have charges of $2,000, $500 and $3,000 respectively for a total of $5,500. That is a debt/credit ratio of 24%. If your first card credit limit doubles to $10,000, the debt/credit ratio decreases 5% to 19%.
The big pitfall is if you cancel one of the large credit limit cards. Let’s say you cancel the $8,000 limit credit card (and paid off the $500), you now have $5000 debt and $15,000 credit. Just by canceling your card, your ratio increased 9% to 33%!
Rule of thumb is to never have a debt/credit ratio over 50%. Always check your ratio before you cancel any card or request a lower credit limit.
MYTH 4. Checking your credit report will lower your FICO score.
A soft pull, such as you checking your own credit or companies periodically checking up on your history, does not lower your credit score. These soft pulls are available for viewing on your credit report including who and when the request was done. It’s not uncommon to see several soft pulls on your report. (A soft pull was done for our apartment rental agreement and appeared on my credit report).
A hard pull, on the other hand,is when you give permission to a lender to access your credit history in order for you to get approval for a credit card or a loan. These hits on your credit history will lower your score by5 points and it may take at least 6 months before you get the points back. As with soft pulls, the hard pulls will be apparent on your credit report and will last up to 2 years.
So have no fear! Check your report often. Remember it’s free from each of the three credit bureaus: TransUnion, Equifax and Experian.
The Little Ones (but just as important)
MYTH 5. You only have one credit score.
You actually have three credit scores maintained by each of the three credit bureaus. Each bureau calculates the FICO score a different way based on the data they report on. It’s not uncommon to have a 50 point variance between reports.
MYTH 6. When you get married, you now have joint credit score.
Your good credit, their bad credit…yes ’till death do you part. Getting married does not help your credit score. You will continue to maintain your own score. Joint accounts will be reported on each individual credit report.
MYTH 7. Looking for the best loan will hurt your FICO score.
I was always hesitant to try Lending Tree because I was afraid that all the hits on my credit report would lower my score thus not allowing me to get a good rate on a loan. After looking into it, I found that that is not the case, however, you must make sure that the inquiries take place within 14 days of each other. One exception, credit card applications.
MYTH 8. A higher salary means a higher credit score.
False. Salary has no impact on you credit score. Salary is only involved to determine the amount of the loan or possible credit limit for a credit card.
I can’t stress this enough, be sure you are checking your credit report every 4 months at a minimum (since it’s free)! Beyond the myths, any mistakes on your report could prevent you from obtaining credit.