5 Myths That Can Hurt Your FICO Score
Credit – it’s not just for credit cards. Credit plays a major role in determining your ability to borrow money, but it is used in many other places that you might not think of. For instance, some employers will check your credit history as a pre-requisite to your being hired. When you rent a home, most landlords will check your credit history to ensure you aren’t too much of a risk to rent to. And when you want to shop around for a better price on your insurance, you better make sure your score is up to snuff.
Do we really understand how our use (or abuse) of our credit can affect our FICO scores? Your FICO score is a vital indication of your “credit health” and that little number can make a huge difference (especially in today’s credit climate) in what you pay for borrowed money. It is in our best interest to keep our FICO scores as healthy as possible.
To help separate fact from fiction, let’s look at 5 FICO score myths that if followed could do more damage than good.
1. Close old accounts you aren’t using to boost your score.
Although it is true that having “too many” open accounts can hurt your score, by the time you have opened the accounts it’s too late. The act of opening too many accounts in a short time frame is the problem, and closing them will not improve your score. Especially not with the older cards – in fact it could do more damage.
How it can hurt you: Closing your oldest accounts will make your credit history seem shorter and the longer the history the better. FICO looks at the age of the oldest account, the newest account, and the average age of all your accounts when considering the length of your credit history. This history makes up 15% of your score. Also, if you close out these accounts you will be decreasing the amount of untapped credit you have, which in turn makes the debt you do have appear to be more sizable (this is reflected in the debt-to-credit ratio).
Keep the old accounts – make sure they don’t have any annual fees or costs associated with them and put the cards somewhere you won’t use them. If you still want to close accounts for other reasons, take out the youngest with the lowest credit limits. Just be aware it won’t increase your score.
2. Checking your credit report too often can hurt your score.
Often people are confused about what kind of credit check actually affects your score. Ordering your own credit report/score has no negative effect. It’s when you apply for new credit (e.g. a home/car loan or new credit card) when your score could take a hit.
How it can hurt you: If you aren’t checking your credit report you aren’t checking for inaccuracies. To keep your score at it’s highest you must check your report periodically to make sure the accounts and their information are correct. This is even more important now that identity theft is on the rise.
3. Large amounts of unused credit or high credit limits will lower your score.
Having high credit limits available on your cards is actually good, provided you don’t actually use that credit. Your debt-to-credit ratio, which is 30% of your FICO score, is the amount of revolving debt (credit card balances) in relation to the amount of available credit (credit limits). Credit Bureaus use this measurement as a way to judge your ability to manage the credit you have. You want this ratio under 30% if you can manage it.
Example: You have 3 open credit cards with credit limits of $4000, $2000, and $3000, equaling a total credit limit of $9000. You have $1500 on one card and $1000 on a second card, equaling a total credit card balance of $2500. You have used $2500 worth of your $9000 available credit, resulting in a debt-to-credit ratio of 28%. Only 28% of your available credit is being used at this time. The higher the percentage the more likely you could be considered overextended which hurts your score.
How it can hurt you: If you are intentionally keeping your credit limits low (I have a friend who would call and have her credit limit reduced if the credit card companies tried to increase it) you are hurting your debt-to-credit ratio by making your balances appear to be a larger chunk of your available credit. As your credit limit increases (or if your balances decrease) this ratio will lower which results in a more favorable score.
Using the example above, if one of your cards raised your credit limit by $1000 (with your balances remaining the same) your debt-to-credit ratio would drop from 28% to 25%. On the other hand, if you were to cancel the card with the $3000 credit limit without paying down on the other balances of $2500 to counteract the loss of credit limit, your new ratio would be 42%. Ouch!
4. You can get rid of unfavorable history by cancelling the card or paying off the balance.
One of my friends with a less-than-perfect credit history cancelled all her cards in the hopes they would be completely removed from the credit report. Not so. Your payment history makes up 35% of your FICO score and closing the accounts with detrimental histories will not make the negative information disappear. While paying the balance in full is a great move and can improve other areas affecting your score, it will not remove the black smudges on the payment history.
How it can hurt you: Late payments associated with that account won’t go away if you cancel the account. Closing accounts can hurt your debt-to-credit ratio (unless you pay down your other debt to compensate) and it can also affect your length of credit history if you are eliminating older accounts.
If the adverse information is inaccurate be sure to contest it. But if it is correctly reported the best bet is to pay the cards on-time, even if it is just the minimums. Use the card to start building a good solid history of paying on-time and eventually your score will improve.
5. Never using credit cards (or not having any credit cards) will raise your score.
Not having cards may help control your spending if available credit is too much of a temptation to splurge but it won’t help your score. Keep in mind that someone who has managed his credit responsibly will likely have a higher score than someone who has little to no history.
I have a relative that avoids credit cards. He buys everything outright and never carries a mortgage or car loan. Although this is ideal for avoiding interest it is not ideal in terms of building up a good credit history. His score is good but he wishes he was within “bragging rights” range. It is most likely the lack of history and active accounts affecting his score.
How it can hurt you: Having too little credit history can lower your score, and if you have no accounts older than 6 months you might not even get a score at all. They feel it is too little history on which to generate a score. If you have a long but less-than-stellar history and have decided to ditch the cards completely you are losing out on a chance to “redeem” yourself. FICO scores weigh the good and the bad and if you generate more good history your score will improve.
Avoiding paying interest is a great policy to have but that doesn’t mean you can’t build up a credit history. Only spend a small amount on a credit card (maybe charge gas on it) and be sure to pay the balance off every month in full and on-time. That way, you build a favorable credit history and still maintain a no-interest lifestyle.