The experts on Discovery Channel’s “Mythbusters” have tackled the 5-second rule for dropped food and whether the moon landing was faked. It’s high time they took on credit scoring.
Lenders have used these three-digit numbers for decades. The companies that create scores are increasingly open about how they work. Yet myths and misunderstandings about credit scoring still abound.
Myth No. 1: You don’t need to worry about your credit scores. This myth often stems from one of two misunderstandings: that handling your finances responsibly will result in good credit scores, or that credit scores are only important to banks.
Fact: Credit scores don’t measure your income, your wealth or your character. They’re based on how you use credit. If you don’t use credit, your scores may be poor or nonexistent — even if you pay your bills promptly and save prodigiously.
Poor scores don’t just hurt your ability to get credit. Even if you never plan to borrow money, your scores may be used to determine insurance premiums, your ability to rent an apartment and the down payment required for utilities. Choosing not to care about your scores can make your life more expensive.
Score savvy tip: Keeping good scores doesn’t take a lot of work. Just charge some regular bills to a couple of credit cards and set up automatic payments to pay the balances in full each month.
Myth No. 2: You should never close a credit account. Many people these days seem to comprehend that closing accounts can’t help their scores and may hurt them. But that’s led to some paranoia about shuttering accounts, to the point where I often hear from readers wondering whether they should risk closing any account.
Fact: You don’t want to close accounts if you only have a few credit lines showing on your credit reports, or if you plan to be in the market soon for a major loan. Otherwise, closing one account is unlikely to have a big impact, especially if you have plenty of other accounts that remain open.
Score savvy tip: It often makes sense to keep open your highest-limit credit cards, since those have a strongly positive effect on your credit utilization ratios.
Myth No. 3: Too many credit cards are bad for your scores.
Fact: Lenders once feared people with lots of available credit would rush out and charge up a fortune, only to default. Credit score experts have discovered, however, that people who have handled credit responsibly in the past don’t tend to go ape overnight. Having more credit lines is now considered a good thing, because lenders who have reviewed your financial situation have entrusted you with these accounts.
Score savvy tip: Having plenty of credit cards may be good for your scores, but don’t lose track of due dates — one missed payment can devastate your scores. Set up account alerts and consider automatic payments so that at least the minimum balance is covered each month.
Myth No. 4: You can get your credit score for free.
Fact: While you can get a regular look at your credit reports once a year for free, there’s no federal law guaranteeing you a free peek at your three-digit credit score.
If you’ve gotten a score for free, odds are that it was a come-on for costly credit monitoring or that the score isn’t a FICO score — the type of score most lenders use.
Score savvy tip: The free scores available at sites such as Bankrate and Credit Karma can give you a general idea of where you stand with lenders. If you plan to be in the market for a mortgage or an auto loan, you probably want a more precise idea of what interest rates you can expect. You can get your scores from MyFico.com for $20 each.
Myth No. 5: You must be in debt to have good scores.
Fact: There’s no need to carry a balance on your credit cards — having and using a couple of credit cards, and paying off the balances in full each month, will get you good scores.
Score savvy tip: If you’re trying to rehabilitate bad scores, rather than just trying to hang on to good scores, having an installment loan (such as a mortgage, auto loan, personal loan or student loan) as well as credit cards on your credit reports can help you speed the process.