The Top 5 Credit Myths
/By: Jennifer Ulmer
For most, buying a home means having good credit.
There are many myths about credit - the ability to take on debt - and the credit scores that give lenders an idea of the risk that each loan represents. In today's post, we explore a bit of the history of credit scores and five of the top questions that we get from our clients regarding how to manage them.
Where did credit reports and scores come from, anyway?
The 1950s
Up until the 1950s, if you wanted to borrow money there was no standardized way of judging your creditworthiness. Lenders may have based their decision on your past history of paying bills on time, or even via a very subjective character judgment. They often would use factors like how you dressed, gender, race, etc. in deciding if you would be approved for a loan.
The 1970s
In 1970, the Fair Credit Reporting Act was passed to help protect consumers. With its passage, you have the right to view all the information that the consumer reporting agencies have in your file. It restricts access to help maintain privacy and requires written permission from the consumer in most cases (for example, if a new job offer requires a background check as a condition of employment). It also gives you the right to dispute inaccurate information found in your credit history, among many other benefits.
In 1974, the Equal Credit Opportunity Act was passed. Until its passage, it was legal to deny a woman a credit card without her husband’s permission. If you didn’t want to get married, you would likely be unable to open a credit account and start building credit in your own name!
The 1980s
The current FICO score system widely used today was first implemented in 1989. Scores range from 300 to 850 and are determined by payment history, the amount owed, length of credit history, types of credit used, and the number of recent inquiries.
Your credit score is a powerful number and knowing how to improve and/or maintain a good score is important for many reasons. Read on for the Top 5 Credit Myths and tips to maintain your credit.
Myth #1: Carrying a balance is good for my credit score
Carrying a balance on your credit card doesn’t help your score, and in fact, may hurt it. It’s best to pay your balance in full each month. That way you don’t have to pay interest charges and this will help lower your credit utilization ratio (the amount you owe compared to the credit limits on your card). Shawn thinks that this myth was started by the credit card companies themselves to earn more interest!
For those that already pay their cards in full each month, you can take it one step further and make that payment before your statement closing date. This will lower your credit utilization rate, which in turn helps increase your score! You can also call your credit card company and ask for an increased limit.
Myth #2: I pay for everything in cash, so my credit score doesn’t really matter
When taking out loans, your credit score directly impacts the interest rate you receive. Even if you plan to pay cash for all your big purchases, your credit report and subsequent score can impact you in other ways. Experian reports that in states that allow it, 95% of auto insurance carriers will look at your credit history when setting your premiums. Depending on the state and field of work you’re in, you may be required to have a credit check completed as a condition of employment or may be necessary to obtain certain credentials and designations. In addition, many landlords will run your credit before they rent you a place to live.
Pro-tip: Keep your credit utilization ratio below 10% for 1-2 months before you apply for a loan.
Myth #3: I only have one credit score
There are many different credit scores. Companies like Experian, TransUnion, and Equifax have their own scoring models, along with lenders using their own criteria to determine your score and creditworthiness. Your credit card company may offer you a score, and there are companies like Credit Karma that will provide you a score as well. Each of these companies may use a standardized score, or they may use their own formula.
The two biggest factors that impact your score are paying your accounts on time and keeping your credit utilization ratio low. While you can’t control the exact way each provider will weigh your credit history, you can take control and make sure you’re making smart decisions to maintain and/or improve your score.
Pro Tip: If you are looking for ways to maximize your credit score, keep your credit utilization ratio below 10% for each credit card you have for 1-2 months before you apply for a loan. For example, if you have a $10k credit limit, make sure your balance is below $1k at all times.
Myth #4: Closing a credit card you no longer use will help your score
When you close an account you no longer use, like a credit card, it may actually result in a lower credit score. This is due to two different factors - your credit utilization ratio, and the length of your credit history. It’s best to keep older accounts open so that you don’t lose the history of that account from your report, and you won’t inadvertently raise your credit utilization rate by having less credit available to you.
Pro Tip: We recommend keeping a small bill on your old cards like Netflix or Spotify. Set those cards to be paid off in full each month. This will make sure the credit card company does not close your account for inactivity.
Myth #5: Credit only refers to credit cards
There are many different types of accounts that make up your credit report. Having a mix of different account types can help your score as long as you always make payments on time. Different account types include installment accounts- like a car loan, a mortgage, or a student loan. They have a fixed payment for a fixed period of time. Revolving accounts are those that will have a different payment amount each month, like a credit card. You don’t typically have to pay these in full each month. Having different types of accounts can show a lender that you can successfully manage different types of credit and it can help boost your score.
Takeaways
Having a solid credit score is important when it comes to obtaining a loan for a car, a house, or just about anything else. It cannot be improved quickly, so it’s important to monitor your scores consistently - something we make sure we do with our clients. By being vigilant and maintaining healthy financial habits like paying off your balances every month, keeping old accounts active, and only using a small percentage of your allowable limit, you can ensure your credit score will be there for you when you need it most.
Pro Tip: We recommend you keep your credit score above 800 at all times. That will ensure that you get the best rates when you do need to apply for a loan.
If you have any questions on how to manage your credit score and get it above 800, please reach out to us to schedule a call today!
