Your credit history is a reflection of your ability to manage money and borrow responsibly over time, and your credit scores are based on various factors, including the number of credit cards and loans you have and your payment history.
Your credit scores can play a big role in your financial life, and you should understand how and why. To get you started, here are six common misconceptions about credit scores that we need to clear up ASAP.
1. You have one score
You actually have many different credit scores that various lenders use, but according to myFICO.com, "FICO Scores are the credit scores used by 90% of top lenders to determine your credit risk." Generally, everyone has three FICO scores -- one from each of the three major credit bureaus: TransUnion, Experian, and Equifax. Scores range between 300 and 850, and a higher score is usually reflective of a long history of responsible borrowing.
2. Checking your own credit scores will lower them
When you check your own scores, it is known as a "soft inquiry" and has no bearing on your scores. In fact, you can check them as many times as you want.
The inquiries you do need to worry about are "hard inquiries," which occur when lenders check your credit history for the purposes of determining your eligibility for a loan. Some service providers, such as cable companies and wireless providers, may also conduct hard inquiries.
Fortunately, hard inquiries will only ding your credit score by a few points, and the effect is not long-lasting.
3. Closing credit cards will raise your credit scores
One of the factors in your credit scores is the ratio of the debt you owe to your total available credit, otherwise known as your credit utilization ratio. When you shut down a credit card, you reduce your available credit and thereby lower your credit utilization
Let's say you have $20,000 worth of available credit across all of your credit cards, and you currently have a $5,000 balance. Your current credit utilization ratio is 25% ($5,000 / $20,000). You decide to close a credit card, bringing your available credit to $10,000. Now you are utilizing 50% of your credit, which may negatively affect your scores.
However, while everyone's situation is different, if you have no outstanding credit card debt, and you'd like to close an account, you can probably do so with little effect on your scores.
4. Having no credit cards or loans will help your credit scores
In order to build a credit history, you need to demonstrate that you can borrow money and repay it on time. Avoiding any type of borrowing or credit use will not result in higher scores.
5. Your wealth affects your credit scores
Your credit scores are reflective of your debt management and borrowing practices, and they do not relate to your income or savings. That said, note that certain lenders who look at your credit score -- namely, mortgage lenders -- will also want to know about your income and savings, which may influence the loan (if any) they offer you.
6. Your credit scores affect only your interest rates
We all know that your credit scores play a big role in how much credit lenders will extend to you and at what interest rate. However, you may not have realized that your credit can affect some other major areas of your life. Landlords may not allow you to rent their property if your score falls below their threshold. And although potential employers cannot see your credit score, they do have the right to look over your credit report in search of red flags. If you borrow responsibly and aim to maximize your credit score, then you'll lower your risk of being turned down for a home or a job.
Ultimately, your credit history and credit scores reveal a lot about your personal financial story, and you have a great deal of control over how that story is told. As such, you should actively work to maintain a responsible credit record.
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