A credit score is a three-digit number meant to predict whether or not you’ll pay back your debts. It’ll make or break you when you’re applying for any line of credit, from a credit card to a mortgage. And it can be a little confusing.
There are countless articles, blog posts and even books published on the topic of explaining credit scores and clearing up misconceptions. But just in case you don’t have time to read all of that, here are five myths about credit scores, debunked.
This is the biggest misconception about credit scores. It’s easy to think that you have one—and only one—credit score. But the truth is that you have dozens, depending on which credit scoring model is used. The three credit bureaus (Equifax, Experian and TransUnion) each have their own proprietary credit score model, along with other scoring models based on the type of lender requiring a score. A mortgage lender will want to look at slightly different factors than a credit card issuer, so a different scoring model is used. The Consumer Financial Protection Bureau explained these differences and consumer confusion about them in a recent report.
The fact that you have multiple credit scores doesn’t mean you shouldn’t be monitoring your credit regularly. Using an online credit tool [link to creditkarma.com] can help you understand the individual factors that influence your credit score. In other words, you won’t just see your score, you’ll see why it is the way it is.
There are two types of credit checks: a hard inquiry and a soft inquiry. Hard inquiries occur when a lender checks your credit to determine whether or not to lend to you, like when you apply for a credit card or mortgage. This type of credit check will ding your score a few points, although the impact will lessen after just a couple of months.
A soft inquiry occurs when your credit is checked for any other reason—with some exceptions. When you check your credit, it’s a soft inquiry, and it won’t hurt your credit score at all. The same goes for when an employer checks your credit. The tricky part is that some credit checks can be either hard or soft, like when you open a new bank account or apply for an apartment. When you know a credit check is going to be performed, ask to see what kind of inquiry it will be.
In most cases, more debt is actually good for your credit score. But only if you manage it well. Here’s why: If you’re making timely payments on an auto loan, mortgage and some credit cards, you’re proving that you’re a reliable borrower. Future lenders and creditors will see this behavior as a good indicator that you’ll keep paying back your debts in the future. On the flipside, if you don’t have any debt at all, lenders and creditors have nothing to go on, and they have no choice but to consider you a risky borrower.
Just because more debt could help your credit score, that doesn’t mean you should start taking out loans just to build your credit. The purpose of a good credit score is to save you money. If you’re paying back debt, you’re probably spending more money on interest. A better idea is to start off by building your credit with a low-interest credit card. Pay off your balance each month, and you’ll never need to pay interest at all.
Your credit score can change at any point in time, based on something you did, something you didn’t do or something someone else did. If you close an account, your score will change. If you miss a credit card payment, your score will change. If you apply for an auto loan, your score will change. Your credit score isn’t static.
On the other hand, fretting about your score everyday isn’t necessary, either. Checking your credit score once a month should keep you updated with any important changes. And you can enroll in free credit monitoring, which will send an email to you if something significant changes on your credit.
Paying down your credit card debt is always a great idea, and it’s usually good for your credit score, too. But closing a credit card—particularly if you only have a few—can actually hurt your credit score. One of the main factors influencing your credit score is your credit utilization rate. This is basically the percentage of your credit limits you’re using at any given time. It’s best to keep this rate below 30 percent for good credit health. If you close a card with a high credit limit, and you’re carrying balances on other cards, your utilization rate will be inflated, causing your credit score to drop.
There are, however, times when it makes more sense to close a credit card. For instance, it could be a good idea to close a card you don’t use that’s charging you a high annual fee. Otherwise, start using the card again just a little each month; it’ll continue to help you build your credit.