Home » Top 10 Common Credit Score Myths Exploded
Far too many people don’t really understand credit scores. Which is forgivable really, as they are not always easy to decipher. In addition to learning the facts about the credit scoring system, it helps if you understand what ‘common wisdom’ is not very wise at all.
Credit scores are, after all, a big deal. To get a mortgage or any personal loan, you need a good one. Starting a business will mean relying on your personal credit score at first. A credit score can even sometimes be something an employer checks.
With that in mind, here’s a look at 10 of the most common credit score myths we hear from people as accountants, and the reality behind them.
The thinking behind this myth is pretty simple. Paying cash = no missed/late payments = good credit score. The assumption being that “good” credit is the default, which is completely false.
Paying cash (or using debit cards, gift cards, cheques, etc.) for everything prevents you from building a credit history, which means you will likely have a very low credit score or won’t actually have one at all.
Here’s an idea. Get a credit card with a low limit. Use 30% of that limit to do your weekly grocery shopping. Take the cash you would have used to pay for the outing usually and use it to pay the charge off your credit card in full. You’ll be meeting all those credit score building requirements we’ve been talking about, and you still won’t be in debt. A win-win situation if there ever was one.
This is an age-old question about credit cards. What is the right number of cards to have?
We hate the answer “it depends”, but in this case, it seems appropriate.
Allow us to elaborate.
As we discussed above, 30% of your credit score is based on the amount of debt that you owe with respect to your total available credit (called “credit utilization”). In an ideal world, you would always keep your utilization below 30% (i.e. $300 on a credit limit of $1,000). Below 20% would be even better, but 30% is a good benchmark.
But if 30% is the minimum, what is the maximum? Will having a bunch of credit cards hurt your score? Nope, in fact, that will likely help your credit score by reducing your credit card utilization and increasing your number of on-time payments. Generally speaking, there is no such thing as having “too much credit”. As long as you are making all of your payments on time, extra available credit will actually help your score.
In the world of credit scores, there are two types of credit checks, “hard inquiries” and “soft inquiries”. A “hard inquiry” occurs when your credit report is pulled as a result of some sort of application for credit (credit cards, mortgages, car loans, etc.). Each hard inquiry dings your credit score by roughly 2-5 points, depending on a variety of other factors.
A “soft inquiry” occurs when you pull your own credit report or when a company pulls your report for a non-credit use, such as a background check. Unlike a hard inquiry, a soft inquiry has no effect on your credit score. So how do you go about checking your score (and not hurting it)?
Go straight to the source. Canada has two credit bureaus in charge of calculating your scores, TransUnion Canada and Equifax Canada, and both will provide you with a copy of your credit report if you make a formal request and verify your identity. Don’t bother with paid sites that ask for your credit card info. They will end up charging you a monthly fee for a bunch of credit monitoring services that you probably don’t need.
This myth is related to the number of credit score myths, but the number of questions we receive about it on a weekly basis justify a separate entry. Generally speaking, you should never close a credit account unless you have a reason to.
Common reasons include avoiding an annual fee, transferring your credit to another card, etc. Never close an account just for convenience. But why? Closing accounts reduces your total available credit, causing your credit utilization to increase and therefore your credit score to fall. Closing accounts also prevents you from building additional credit history, which makes up 15% of your score.
This myth persists because people think that closing an account will remove it from their credit report, therefore hiding any bad history from future lenders. Just like bad relationships, you can’t just delete all the evidence of a bad credit account and forget that it ever happened. Only time heals. The account will remain on your credit report for up to 10 years, at which point it will fade away. Just like those bad memories of your terrible ex.
The best course of action is to keep the account open and in good standing, allowing you to build credit history and maintain a good credit utilization ratio.
We have never really understood this myth. We’re supposed to believe that by not making payments on time, we are somehow improving a metric that measures my likelihood of making my payments on time? The most common justification for this practice is the belief that carrying a balance on your credit card is the only way to build credit history, which makes up 15% of your score. After all, having no balance means you have no credit history, right? This is completely false. You are building credit history regardless of whether or not you carry a balance on your card. Carrying a balance will only leave you with tons of late fees and interest charges.
If anyone tries to tell you to follow this advice, please do us all a favor and punch them squarely in the face.
This is like believing that starting a diet will instantly make you skinny. The truth is that your credit report reflects your history of using credit, not just a snapshot of your current situation. Even after being paid off, it can take as many as 7-10 years for a debt to fall off of your credit report. So if you are looking for a quick fix for your credit score, this is not it.
This myth is perpetuated by all of the advertisements that encourage you to “check your credit score” as if there is only one score that is used for everyone.
We wish it were that simple.
The truth is that there are dozens of credit scoring models that are used to predict your likelihood of default. Each of them is a little different and at times can produce dramatically different scores. While we would love to discuss each of them with you (actually, that sounds awful), we’ll save us all the time and cut to the chase.
The most widely used credit score are those issued directly from the two credit reporting agencies mentioned earlier. Other credit scoring models are often referred to as “FAKO” scores. While these scores can be really useful for getting a basic idea of where you stand, the genuine scores are the ones that really count.
We have found that this is more of an excuse than a myth. People with bad credit tend to bring this up when they are confronted with the idea of repairing their credit score. While there are certainly no “quick fixes” for a credit score, it can be rebuilt with a little bit of patience and discipline. The key is to start making your payments on time and building a history of responsible credit use.
Your income, education, net worth, etc. have absolutely zero effect on your credit score. Lenders use such things, but that’s a very different matter. Your credit score is a reflection of your ability to pay your bills on time, not your current financial standing. It cannot be improved simply by earning or saving a lot of money.
In addition to being used in credit decisions, credit reports can be used by current and potential employers to aid in employment decisions. While they cannot see your actual credit score, employers are able to view a modified version of your credit report that includes information about loans and credit cards listed in your credit report.
This practice is especially common in industries such as banking or finance, where employees are responsible for dealing with a client’s personal finances. This is just another reason why your credit score is such a crucial component of your overall financial well-being.