Misconceptions about Credit Scores

The way you handle your money is heavily influenced by your credit score. Make sure you know what I'm talking about. Everyone, from landlords to insurance companies to utility companies and even potential employers, checks your credit score. It varies from 300 to 850 and is based on information in your credit reports.

However, a recent survey found that almost half of all Americans are unaware of the process or elements utilized to calculate these rankings.

As an illustration, a person with a credit score of 720 would likely pay nearly three percentage points less in mortgage interest than someone with a score of 580.

If you want to reframe it another way, the monthly payment for a 30-year fixed-rate mortgage of $150,000 with an excellent credit score would be approximately $890. This is in accordance with what Fair Isaac, the business behind the FICO score and the rate's namesake, has to say. But if your credit is bad, you may easily end up paying more than $1,200 per month for that identical loan.

Knowing what a credit score is and how it is impacted is crucial because of how much is riding on it.

A lot of people, unfortunately, have a lot of false beliefs and assumptions regarding their credit score. The following are five widespread misconceptions about credit scores, along with the facts:

1. The main credit reporting agencies do not all utilize the same formula to determine your score.

Details: Equifax, TransUnion, and Experian, the three main credit reporting agencies, all use different names for the score. There are a few different names for the same credit score: "Beacon" at Equifax, "Empirica" at TransUnion, and "Experian/Fair Isaac Risk Model" at Experian. Although the credit score goes by a few different names, the mechanism that calculates it is standard across all of them.

Your credit score could vary from one credit bureau to the next due to differences in the data used to calculate it. For instance, one bureau's data can extend further back in time than the other two, or a prior lender might have supplied information to just one bureau.

In most cases, the scores are quite close to one another. For the purpose of evaluating your application, many lenders will simply adopt the middle bureau's estimate of your credit score unless there is a significant discrepancy. Just because of this, it's smart to fix any mistakes at each of the three main credit reporting agencies.

2: If you want to fix your credit score right now, all you have to do is pay off your bills.

Fact: Your present debt level is less important than your performance history when calculating your credit score. Paying off your credit cards and loans will help a lot, but if you have a history of late or missed payments, it won't fix everything immediately. Raising your credit score is an ongoing process.

Pay off your debts, without a doubt. Paying payments on time should be a habit you establish for yourself.

3. My credit score will increase if I close old accounts.

Contrary to popular belief, this is not true. Your credit score is affected when new accounts are opened, not when old ones are closed. Your credit score will never improve—and may even decline—after you close an account. Indeed, a low credit score can be a result of having numerous open accounts. The harm, however, is done the moment the accounts are opened. Closing the account won't fix it and can make matters worse.

When available credit is less than used credit, the credit score takes that into account. Your actual credit balances will appear higher when compared to the amount of credit you can utilize because closing accounts reduces the total amount of accessible credit. The impact on your credit score is negative.

A customer's credit score also takes their credit history length into account. Removing activity from dormant accounts can make your credit report appear more recent than it actually is. Furthermore, this may lower your score.

In most cases, you should wait to cancel an account until the lender demands it as a loan requirement. Instead, you should focus on reducing the amount of debt you already have on your credit cards. Your credit score would unquestionably rise if you did that.

4. Comparing loan offers will have a negative impact on my credit score.

It's true that a credit inquiry can lower your score by as much as five points. Borrowers who shop around by applying with multiple lenders may be concerned that their credit score will take a hit with each inquiry. Do not believe this. As long as they occur within 45 days of each other, numerous loan inquiries are counted as one inquiry for the purpose of calculating credit scores. This 45-day window is therefore optimal for rate shopping.

5. I can pay a company to raise my credit score.

A history of poor debt management will not magically raise your credit score if the credit bureaus have your precise information. Demonstrating your future ability to manage debt is the only way to influence your credit score.

A person can also contact the bureau independently in the event that their file has inaccuracies. Hiring a third party is unnecessary. You may find detailed instructions on how to dispute an inaccurate report on the websites of the three main credit reporting agencies.

To enhance your credit score, it is recommended that you pay off your debt, pay your payments on time, dispute errors on your credit reports, and rarely apply for credit.