A credit score is a metric that lenders use to measure the creditworthiness of a borrower. It’s an essential part of your financial life. And how often you get loans with juicy interest rates depends on your credit scores. However, there is a lot of false information out there about credit scores. So, in this article, you will learn some of the misconceptions people have about credit scores.
Generally, people have little or no knowledge about credit scores, what hurts them, and what increases them. That explains why a lot of people have low credit scores and always get exorbitant interest on loans. In fact, according to several polls, only 1 in 8 Americans actually know their credit score.
Surprisingly, your credit score affects almost every aspect of your life. That’s why some landlords won’t rent out their houses to tenants with low credit scores. Also, insurance companies use your credit scores to set your auto and home coverage premiums. And some companies may not even employ you if you have a low credit score.
Here are some misconceptions people have about credit scores:
#1. Your Income Impacts Your Credit Score
This is one of the greatest misconceptions people have about credit scores. It’s a common belief in the US that the higher your income, the higher your credit scores.
This couldn’t be further from the truth. Your credit score has nothing to do with the amount you earn. In fact, your income isn’t part of the variables used to calculate your credit reports.
When calculating your FICO credit scores, here are some of the variables used:
- Your payment history; explains how often you pay back your loan, and it accounts for 35% of your FICO credit score.
- The amount owed; explains the amount of your indebtedness. It accounts for 30% of your credit score.
- The length of credit history (15%)
- New credit (10%)
- Your credit mix; it’s the type of account that makes up your credit report. It determines 10% of your FICO credit score.
When it comes to loan applications and credit cards, lenders look at your credit score, which determines your loan worthiness.
#2. Applying for a New Credit Card Doesn’t Hurt Your Credit Score
It’s not true. An application for a new credit card can affect your credit score. But most people don’t understand this.
When you apply for a new credit account like a credit card, mortgage, phone contract, etc., the lender will always carry out a hard inquiry to check your creditworthiness.
It’s a normal procedure for opening new credit. And if lenders perform more than 2 credit inquiries about you within 12 months, it may hurt your credit score in the long run.
Ordinarily, applying for a new credit card itself won’t hurt your score. But the process involved may seriously affect your credit score for a long time, especially if different lenders perform hard inquiries about your credit score within a short time.
It gives lenders the impression that you are desperate for a loan. And lenders don’t like giving loans to desperate borrowers.
#3. Closing Credit Card Accounts Will Improve Your Credit Score
This is yet again, another myth. It’s one of the misconceptions people have about credit scores. Contrary to what you may think, closing your credit card does more harm to your credit score than good.
When you close your credit cards, your credit limit in relation to the debt you owe will reduce. And when this ratio increases, your credit score will reduce.
Even though you aren’t using your credit cards often, their history will remain on your credit report. Interestingly, a blend of good payment records and your credit account’s duration improves your credit score.
So, instead of closing your credit card, leave it open for a while. It will boost your credit rating over time.
#4. People With Good Credit Scores Are Rich
Of course, it’s not true. Your credit score doesn’t determine whether you are rich or poor. It only measures your credit risk.
If you have a good credit score, it means you are a good risk. And more lenders will be willing to lend you money at a relatively lower rate.
But if your credit score is poor, most lenders will see you as a bad or poor risk. They won’t want to lend you money because you aren’t creditworthy. And the few that are willing to lend will do that at an exorbitant interest rate.
So, your income won’t give you a higher credit limit unless you update your income to a higher amount. This will help you to increase your credit limit. It has nothing to do with your credit score.
However, some cards don’t have preset spending limits. That means there’s no credit limit. You can opt for these credit cards if you are creditworthy. Do your research to see which cards have the best offers.
#5. You Have a Good Credit Score if You Don’t Have credit
This is one of the worst misconceptions people have about credit scores. Most people believe that since they haven’t been indebted to any lender in the past, they have good credit scores.
Of course, the explanation makes sense, and the analysis is rational. But that is not how credit scores work. You need to have an established credit account when applying for a mortgage loan, securing a credit card, and even student loans. Otherwise, lenders cannot accurately predict if you are likely to pay your loan as agreed or not. So, they will see you as a high-risk borrower.
Even if the lender agrees to oblige you with the loan, you will need a cosigner with a good credit score. And such loans will definitely attract higher interest rates.