5 Reasons Credit Scores Don't Make Any Sense
by Lyle Daly | Updated July 21, 2021 - First published on March 18, 2021
Credit scores may seem precise, but some factors in how they're calculated are far from logical.
Whether you like it or not, your credit score is a big part of your everyday life. You'll have a much easier time financially with a higher credit score. But as you try to increase your credit score, you may find yourself running into a frustrating issue -- credit scores aren't nearly as intuitive as you'd think.
Things that seem like they'd help your score can actually hurt it, and vice versa. In situations like these, you could wonder why a smart, responsible financial decision (like paying off a loan) made your credit score drop.
Simply put, there are plenty of ways credit scores don't make sense. But when you're aware of these oddities, you can make sure they don't trip you up as you work toward good credit.
1. You need to borrow money to build credit
A credit score is an assessment of your credit worthiness. Based on that, you'd think that having zero debt and paying all your bills on time would be points in your favor.
Unfortunately, it doesn't work that way. To build your credit history, you need a credit account, meaning either a credit card or a loan. If not, you'll have a low or nonexistent credit score because of a lack of information on your credit file. On the bright side, you can use a credit card and avoid interest charges on your purchases if you pay in full every month.
2. Late payments don't hurt your credit until they're 30 days past due
You may have heard that a late credit card payment is bad for your credit score. That's true, but only when you're at least 30 days late.
Every month, your card issuer sends an account status code to the credit bureaus that calculates your credit score. The code for current accounts, meaning those that are up to date on their payments, applies to accounts that are anywhere from zero to 29 days past due. The next code covers those that are 30 to 59 days past due.
If you pay your bill when it's 29 days late, it's considered an on-time payment for credit scoring purposes (even though your card issuer can still charge a late fee). But if you pay a day later, then it can knock up to 110 points off your credit score.
3. Having more credit cards can help your credit
Your credit utilization ratio is a significant part of your credit score. This ratio is your credit card balances divided by their credit limits. Since a lower ratio is better, you can benefit from having more credit cards.
Let's say you have one credit card with a $500 balance and a $1,000 limit, for a credit utilization of 50%. Your friend has four cards with combined balances of $1,000 and combined credit limits of $10,000, for a credit utilization of 10%.
Despite having more to pay off, your friend is doing better from a credit score perspective. Thanks in part to their higher number of credit cards, they have much more credit, which keeps their credit utilization lower.
4. Paying off a loan can lower your credit score
This one always throws people for a loop. How can paying off debt hurt your credit?
There are two reasons this can happen. The age of your credit accounts affects your credit score. When you pay off a loan, that account is no longer on your credit file. If it was one of your older accounts, then that loss will ding your credit score.
Your credit mix also affects your credit score. It's better to have both credit cards and installment loans compared to just one of the two. If you pay off your only loan and are left with just credit cards, then your credit mix will get worse.
5. Minimum and full payments count the same on your payment history
Even though it's better for you to pay your credit card bill in full, you don't get extra credit for it. When it comes to your credit history, an on-time payment is an on-time payment. It doesn't matter if you paid the minimum or the full balance.
To be fair, there are other advantages to paying in full. You avoid credit card interest, which will save you money. It can also keep your credit utilization ratio lower, which can help your credit score.
It's definitely confusing to learn about the factors that can affect your credit score. Just keep in mind that you don't need some complex strategy to build credit. Some things may occasionally affect your score in ways you didn't expect. But all it really takes to get good credit is using a credit card, paying on time, and not letting your balance get too high.
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