Understanding Credit Scores
Did you know that your credit score is the most valuable 3 digit number that you will ever own? Don’t believe it? Well you should. Your credit score will either cost you money or save you money. It all depends upon your financial behavior. Creditors, banks, lenders and insurance companies use that little 3 digit figure to judge you and your financial behavior. Your credit score tells them what kind of financial risk you are. These financial institutions believe that if your score is too low you are not financially responsible so they either deny you access to their services or charge you more.
Your credit score determines how much your rent payment or mortgage payment will be. It determines how much you will pay in auto and home insurance premiums. And for that matter, the interest you will pay on a car loan or if you can even qualify for a loan at all. Your score can even change your utility bills and cell phone rates. If you want to take more control of how you spend your money, learn the myths about credit scores.
Do you know what really effects your credit score and what doesn’t? Some of your financial actions are damaging your score without you even knowing it. Protect your most valuable 3 digit number, learn the truth about credit scores. There are 6 common misconceptions people have about the impact their financial behaviors have on credit scores. Let’s talk about these 6 myths in greater detail.
Myth #1 – Your Income Influences Your Credit Score
Your income is not factored into your credit score.
Your income comes into play when you are applying for a loan, but your income does not affect your credit score. You can earn a high salary and still have a bad credit score. Now, if you make good money and blow it, then your credit score could be damaged. Racking up your credit cards by spending more than you earn could hurt your credit score. Thirty percent of your credit score is based on what you owe. It’s called your credit utilization ratio; the industry likes to see a credit utilization ratio of less than 30%. This ratio takes your total debt and divides it by your total credit. For example, if your credit card limit is $5,000 and your rack up credit card balances totaling $2,000, your credit utilization ratio would be 40%.
Myth #2 – Closing Credit Cards Is Good For Credit Scores
Closing a credit card can have a negative effect on your credit score.
When you close a credit card you effect that credit utilization ratio we just talked about. Since your credit utilization ratio is the amount of credit available to you compared with the amount of credit you use, by closing a credit card you lower the amount of credit available to you which adjusts your credit utilization ratio.
There is no value to closing credit cards; it will not raise your credit score nor will it eliminate any credit history. Active outstanding balances will continue to be used to calculate your utilization ratio even if you have closed the credit card. Any outstanding balances have to be paid down to zero and recorded on the credit report to have a positive effect on your utilization ratio.
Myth #3 – Checking Hurts Your Score
True and false
This is a Catch-22.
If you check your credit report you do not hurt your credit score because it is considered a soft hit. However, when a creditor pulls it for lending purposes it is a hard hit. This action could have a negative effect on your score if there are too many hard hits. When you apply for a mortgage loan the lender is keenly aware of the number of hard hits that show on your credit report.
Even if you always pay your bills on time your credit score may still suffer.
Mistakes occur and inaccurate information can be reported. You need to check your credit report at least once a year. By checking your credit report you stay on top of any inaccuracies and can correct them on a timely basis. Credit reporting agencies just collect and report credit data; they are not responsible for checking the accuracy of that data, that is your responsibility.
By not checking your credit report for errors at least once a year you are assuming perfection, and that is impossible. With identity theft running rampant nowadays it is dangerous to assume perfection. Besides the law allows you to get a free credit report once every year so why not take advantage of that to keep your credit score in check. Checking your score when you are applying for a loan or denied one is the wrong time to be on top of the situation. Order your free credit report today to at least know what you have to work with.
#5 – Paying Cash Guarantees A Good Credit Score
Paying cash and never using credit can actually damage your credit score.
When you pay cash you never get a chance to prove to creditors that you can manage debt. Thirty five percent of your credit score is based on your payment history so building up a credit history is very important. Without a credit history, you are viewed as a higher risk than individuals who have a credit history and manage their debt responsibly.
Now with that in mind, do not make the big mistake of opening 5 or 6 new credit cards just because you think that will prove that you can. This action will hurt your score, not help it. Lenders and creditors will view you as a risk gone wild. Too many credit cards (especially opened within a short period of time) gives the impression that you will be unable to manage your payments. And to a creditor, there is nothing worse than late payments. So, open one credit card at a time. Create a balance and pay that balance off in full every single month for six months to a year before opening another credit card. Your ability to create debt and pay if off in a timely manner impresses creditors more than paying in cash.
#6 – Tiny Debts Don’t Count
All kinds of debt is fair game and can be used against you.
Even library fines and unpaid parking tickets can affect your credit score if they are reported. Libraries and municipalities need money so even though it’s hard to believe, these institutions have been known to report small unpaid debts to collection agencies.
Creditors want to get paid. They do not like debt, unless it’s their debt that they get to charge you high fees on. So be careful to be aware of debts that you may have ignored in the past on the basis of size. Always remember that all debt can have a negative influence on your credit score.
Take Advantage Of Your Credit Score
You are in charge of your financial life. Use your credit score to your advantage; raise it and lower your spending. If you are tired of paying too much on your auto insurance, utility bill or credit card interest rates, work on your credit score. A higher score will save you so much money, you will be surprised.