Article by Selena Maranjian | Featured on CNN
Whatever your credit score is, it could probably be higher.
Many people are taking steps to improve their credit worthiness — but if they go about it the wrong way, misled by myths, they could actually hurt their scores.
Here are three myths that could tank your credit score — and below them, some misunderstandings about credit scores that could also hurt you:
Myth No. 1: Closing out credit card accounts will boost your score
Many people assume that if they close out a bunch of credit card accounts, their credit scores will rise. After all, having fewer cards means less possible debt, right? Well, not exactly. Check out the components that determine your FICO score, which is the most commonly used credit score:
- Payment history — 35%
- Credit utilization (amount owed vs. limit) — 30%
- Length of credit history — 15%
- New credit –10%
- Other factors such as your credit mix — 10%
Closing credit card accounts can actually hurt your score. That’s because your score takes your “credit utilization” into account, comparing how much you have borrowed with how much you could borrow (i.e., all your various credit limits). If you close an account, you lose that credit limit, so your credit utilization ratio will rise.
For example, if you owe $4,000 and your combined credit limit is $20,000, your credit utilization ratio will be $4,000 divided by $20,000, or 20%. If you close an account and your total credit limit drops to $12,000, your ratio will rise to 33%.
Note that if you ever want or need to close an account, it’s best to close newer accounts, as older accounts are more valuable, demonstrating a long credit history. Or close ones with low credit limits. You’ll rarely need to close accounts, though. Just lock up some cards and stop using them. Or perhaps close out one account every six months or so.
Myth No. 2: Not using credit cards can boost your credit score
Another seemingly reasonable myth is that you’ll have a good credit score if you don’t use credit. That’s not the case because a credit score reflects how good a credit risk you are, and it’s based on your credit record — your history of borrowing and paying back money. If you haven’t done much or any of that — perhaps by not having or using credit cards and/or by not taking out a car loan or mortgage — then you’ll be a mystery to potential lenders. When you want to borrow money, they won’t be able to offer you the best interest rates, because they won’t know if you’re a good or poor risk.
Ideally, you want to be using credit and doing so responsibly. You should be paying off bills on time and in full when possible.
Myth No. 3: Only late payments of certain debts will hurt your score
You might assume that your credit score is only whacked when you’re late making mortgage payments or paying credit card bills or paying off other debts such as car loans. Not true. Just about any creditor can report you to credit agencies — landlords may report you, as might owners of a storage unit you rented and plenty of others to whom you owe money. Even a late or unpaid library fine can end up dinging your score, as can overdrawing on a line of credit at your bank that’s meant to protect you from overdraft fees.
Here are a few more credit misunderstandings that can hurt you:
Misunderstanding No. 1: Assuming you have a good credit score
Never assume that your credit score is good. Sure, you might be the most responsible credit user, paying bills on time and in full — but there might be an error on your credit report that results in a lower-than-expected score. It’s smart to check your credit report regularly, especially before you need to borrow money. Give yourself time to increase your credit score if you have to.
You’re entitled to a free copy of our credit report annually from each of the three main credit agencies — visit AnnualCreditReport.com to order yours — then check it for errors and fix any that you find.
Misunderstanding No. 2: Thinking that every time your score is looked up, it gets reduced
There’s actually some truth to this. That’s because there are two different kinds of credit inquiries — a “hard pull” and a “soft pull.” A hard inquiry involves a lender looking into your credit report because you are applying for credit — perhaps wanting a car loan, a mortgage, or a new credit card. Your consent will be required for this, and this inquiry is likely to shrink your credit score by a small amount — around five to 20 points. Note that if you’re shopping around with a bunch of lenders and they all pull your credit report within a few weeks, it will generally count as just one inquiry.
A soft inquiry, meanwhile, will not affect your credit score — which is good, as these inquiries generally happen without your even being aware of them. If you get credit card offers in the mail, for example, it’s likely that the card issuer has looked into your credit record in order to determine whether it wants you as a customer. Looking up your own credit report is another soft inquiry that won’t hurt your score.
Misunderstanding No. 3: Thinking that your low credit score means no loans
Even with a rather low credit score, you can still borrow money. But you’ll be offered much steeper interest rates than you’d get with a healthy score. Consider the table below, which shows you some recent sample interest rates from the folks at FICO that borrowers with various credit scores might be offered — and what kind of difference the rate will make in your payments. If you were borrowing $200,000 via a 30-year fixed-rate mortgage, and you had a top FICO score, in the 760 to 850 range, you might get an interest rate of 3.568%, with a monthly payment of $906 and total interest paid over the 30 years of $126,051. If your score was 630, though, your rate would be very different, at 5.157%, with a monthly payment of $1,093 and total interest of $193,449. That’s $185 more per month ($2,220 per year) and a whopping $67,398 more in interest.
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