Shattering the myths about credit scores

separate fact from fiction to take control of your score

Chicago TribuneJanuary 13, 2013 

20120918 Credit score

300 dpi Rick Nease illustration related to falling credit scores for college students. Detroit Free Press 2012

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NEASE — MCT

  • Credit truths

    Some seemingly false perceptions about credit are actually true or close to it.

    Your credit affects your insurance premiums: Wacky-sounding but true. Though there doesn't seem to be a relation between your credit use and whether you're involved in a car crash, some auto insurance companies consider your credit scores in determining insurance premiums. They insist there is a correlation between a consumer's credit and the claims he or she is likely to file.

    Employers check your credit scores: Employers don't check scores, but they might look at your credit reports, which is the only thing you can control anyway.

    Visiting a credit counselor hurts your credit: Using a debt counselor and getting advice doesn't hurt your credit. However, if you end up allowing a counselor to negotiate settlements with creditors — paying them less than you owe — that will hurt your credit, said Adam Levin, co-founder of Credit.com. That doesn't mean you shouldn't see a debt counselor, however. Most people considering debt help have lousy credit scores anyway.

Perhaps no area of personal finance is more confusing than credit.

That's because some of the basic tenets of credit scoring seem illogical.

For example, why does it help my credit scores if I have many credit accounts but hurts my scores if I cancel a credit card?

It's no wonder that myths about credit reports and credit scores abound.

Liz Weston, author of four editions of the book Your Credit Score, said she hasn't had to rewrite the chapter on credit myths over the past decade. "I keep hearing the same misinformation over and over and over," she said.

But it behooves us to separate fact from fiction.

Not only will a better credit rating help consumers get the loans they want, those loans will cost less because the best financing rates go to those with the best credit. And credit reports have started to be used for other purposes, such as hiring and setting insurance premiums.

"Credit can be a wealth builder," said Adam Levin, co-founder of Credit.com.

Here are some of the most important myths to dispel:

Your credit is out of your control. "I think the biggest myth of all, and people have to get it through their heads, is that credit is not something that happens to you," Levin said. "Consumers can play a role so their credit report is a résumé and not a rap sheet."

Your credit reports are simply a record of your actions — the credit accounts you have opened, such as credit cards, mortgages and car loans, and whether you pay those bills on time.

You can check your credit reports once a year for free at each of the big three credit agencies — Experian, Equifax and TransUnion. Check those reports at AnnualCreditReport.com or call 877-322-8228, and report any errors that might look bad to lenders.

Checking your own reports is also a good way to monitor whether you're a victim of identity theft — if someone has opened new credit accounts in your name.

Information from your reports is funneled into a formula that can spit out a three-digit credit score. The score is a shorthand way for lenders to assess your reports quickly without actually reading them.

Credit scores are simply a numerical snapshot, usually ranging from 300 to 900, of what's contained in your reports that day. If you're curious to see how you stack up against other people, access a free score online from such sites as Credit.com, CreditKarma.com, CreditSesame.com and Quizzle.com.

Be aware that your credit is tied to your Social Security number, so you'll have to provide that number to get reports and scores from these websites. Ignore sales pitches, especially for credit monitoring.

Having too many credit accounts hurts your rating. Oddly, the opposite is usually true. Common sense might suggest that if you have more credit accounts open, you have more ability to get into debt trouble and not pay your bills on time. But that's not the way scoring formulas look at it.

Instead of looking at how much credit you have, scoring systems look at your "credit utilization," how much of your available credit you're actually using at any given time. Credit experts are usually reluctant to say exactly what the ideal credit use is, but when pressed, Levin said it's 10 percent, as ridiculous as that sounds.

A simple example: If you have two credit cards with $5,000 limits each, you want to keep charges on those cards below a combined $1,000, which is 10 percent of the total $10,000 credit line. Again, the 10 percent rule is to maximize your score. You can still have a great score — and get approved for the loans you want — if you use more than 10 percent of your available credit.

I should close a credit card account I don't use. Probably not. Closing a card account means you don't have access to that credit anymore. And, again, lowering the amount of your available credit is detrimental.

If you had the credit card for a long time, closing it hurts even more because scoring formulas consider how old your accounts are, with older accounts being better because they have long payment track records. There's no harm in leaving card accounts open even if you don't use the cards, unless they charge an annual fee.

However, if a credit card account is relatively new — just a few years old — and has a relatively low credit limit, closing it won't matter much.

There is one true credit score. In fact, you have many scores. There are different brands of scores — FICO is most used, but many others are available to lenders. And then there are scores tailored to the type of loan you're applying for. The formula for mortgage credit scores is different than for auto-loan scores.

"You could have as many as 120 active credit scores," Levin said.

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