Your credit score plays a crucial role in your financial life, impacting everything from loan approvals to interest rates. However, most people have only a surface-level understanding of credit scoring. This article dives into little-known facts and debunks common myths about credit scores.
According to recent studies, credit card balances jumped 15% in 2021; the largest increase in over 20 years. The average revolving credit card debt per U.S. household now stands at a whopping $7,486. While many believe carrying a balance can benefit your score, statistics reveal this concerning trend of rising average credit card debt in America.
Consistently maxing out your credit cards is risky. High utilization rates can drastically pull down your credit score. The key is to keep your balance modest relative to your total credit limit. Beyond impacting loan and credit card approvals, your credit score also influences rental and job applications, insurance premiums, and more.
1. Checking Your Own Credit Doesn’t Hurt Your Score
Many people avoid checking their own credit report, fearing it might negatively impact their score. However, this is a myth. Accessing your personal credit report is considered a “soft inquiry” and does not affect your credit score at all. Soft inquiries can be made by individuals or companies for non-lending purposes and are not visible to potential lenders.
On the other hand, “hard inquiries” made by lenders when you apply for credit do show up on your report and can temporarily impact your score. But checking your own credit qualifies only as a soft inquiry, so you can view your credit report worry-free, an important step in navigating your finances.
2. Late Payments Can Stay on Your Report for Seven Years
Think a single late payment isn’t a big deal? Think again! A delayed payment can decrease your credit score by up to 100 points instantly. Even worse, it can taint your credit history for many years.
As per FICO guidelines, a late payment can remain on your credit report for up to seven years from the date you missed your due date. Set payment reminders and carefully monitor your account activity to avoid such credit score disasters.
3. Carrying a Credit Card Balance Isn’t Necessarily Good
A common misconception is that maintaining a credit card balance can benefit your credit score. However, statistics reveal a concerning trend. Credit card balances jumped 15% in 2021 – the largest increase in over 20 years. The average revolving credit card debt per U.S. household now stands at a whopping $7,486.
While an occasional small balance is acceptable, consistently maxing out your credit cards is risky. High utilization rates can drastically pull down your credit score. The key is to keep your balance modest relative to your total credit limit.
4. Credit Utilization Rate Impacts Up to 30% of Your Score
Your credit utilization rate, which is the amount of revolving credit you’re currently using divided by the total credit available, influences up to 30% of your credit score.
According to Experian, a high credit utilization rate conveys credit risk, while a low rate indicates responsible management. To boost your score, keep your utilization as low as possible without completely stopping card use. Aim for a utilization of 30% or less.
5. Beyond Loans: The Extended Reach of Your Credit
Your credit score has a far broader impact than simply loan and credit card approvals. Many landlords refer to credit reports and minimum score requirements before renting apartments. Certain employers also check credit as part of the hiring process.
Additionally, your credit can influence auto and home insurance rates in many states. Insurers may label those with lower scores as higher risk and charge more in premiums. Monitoring and building your credit is critical for your financial health.
6. Multiple Versions of Credit Scores Exist
Whenever you hear references to a credit score, it’s essential to understand there isn’t just one unified version. The two most common credit scores are the FICO Score, calculated by Fair Isaac Corporation, and VantageScore, created jointly by the three major credit bureaus.
While both share similar rating scales and factors, the scores can vary significantly for an individual. Checking both your FICO and VantageScore gives you a more complete picture of your credit health.
7. Millions of Americans Are “Credit Invisible”
As per the Consumer Financial Protection Bureau, nearly 26 million Americans are “credit invisible” – they simply do not have enough credit history for a score. An additional 19 million are said to be “unscorable” due to inactive or outdated credit.
Building credit takes diligence and patience. Consider secured cards requiring a deposit or becoming an authorized user on a family member’s account. Pay all bills on time and judiciously take on new credit to establish a strong credit history.
8. You Can Add Positive Information to Your Credit Report
Most people focus solely on avoiding negatives like late payments, defaults, and excessive debt. However, you can also actively enrich your credit reports with positive information.
For instance, Experian Boost allows you to add utility, phone, and streaming service payment history to your Experian credit file. Such steps can provide an added boost to your credit health and overall score.
9. Lenders Can Choose Their Credit Scoring Model
While FICO and VantageScore are the major credit scores, it’s crucial to note that lenders have the freedom to make lending decisions based on the scoring model of their choice. This means the score you check may differ from the one used by a lender.
Increasingly, many creditors are also developing customized scoring models tailored to their unique requirements and borrower profiles. Don’t be disheartened by variability in scores. Focus on fundamentally strong credit habits.
10. AI is Revolutionizing Credit Scoring
The world of credit scoring is being profoundly impacted by artificial intelligence and machine learning. Entirely new credit scoring models are being developed that synthesize alternative data like utility payments, job history, and education.
However, AI-based scores also pose the risk of algorithmic bias and lack of transparency. Oversight mechanisms must ensure these innovations comply with the Fair Credit Reporting Act and lend responsibly.
In Summary
Your credit score is a mirror of your financial habits, and vigilantly monitoring it is vital. While the world of credit scoring is complex, making payments on time, keeping low balances, and periodically reviewing your reports will set you on the right path. Pay attention to your credit’s nuances, and your financial life will reap the rewards.
Frequently Asked Questions
How often should I check my credit report?
Annual checks are recommended to spot any errors or fraudulent activities. Consider checking your reports from Equifax, Experian, and TransUnion to get a comprehensive view.
Does closing a credit card account improve my credit score?
Closing a card can negatively impact your score by decreasing your total available credit and increasing your utilization ratio. Avoid closing your oldest cards, as that reduces your credit history length.
How do different types of debts affect my score?
Credit cards, mortgages, student loans, and other installment loans are weighted differently. Mortgages and student loans are viewed positively. Keep credit card balances low, and make all payments on time.