There aren’t a lot of absolutes in this life. Death and taxes are usually the two things listed among life’s certainties. Well, I’m adding a third: credit score confusion!
I hear from a lot of folks who have misconceptions about credit scores. Our credit score system is extremely complex and it’s not intuitive at all.
So let me assure you right now: It’s not you, it’s them.
That said, it’s important to know that failing to understand how credit scores work can actually hurt your credit score.
Here’s the #1 mistake people make — along with four other common errors — that can really get in the way of a healthy credit life.
The Biggest Credit Score Mistake: Thinking You Have To Carry a Balance To Build Credit
The truth: No, you don’t! You can build a great score without paying interest on your purchases.
This misunderstanding does a lot of damage because people leave partial balances on their credit card bills even when they have the money to pay them off each month.
Running a balance won’t help you build credit. More often, it ends up hurting you, because you end up with a credit utilization ratio that’s too high, and/or you pay a lot of unnecessary money in interest charges.
Here’s the responsible — and cheap — way to use credit cards:
- Have a budgeted amount that will go on your credit card each month.
- Track your spending so you stay within your card’s budget.
- Don’t charge more than 30% of your available credit. Keep it below 10% if you want to increase your credit score quickly.
- Pay your bill in full every month and always by the due date.
Stick to this plan and you’ll be on your way to an excellent credit score. And don’t forget to pay all of your bills on time, not just credit cards.
Your payment history makes up a whopping 35% of your FICO score, so do whatever you need to do to remind yourself when bills are due.
4 More Mistakes That Might Be Dragging Your Credit Score Down
1. Believing a Higher Income Results in a Higher FICO Score
The truth: Your income is not considered in credit score calculations.
A financially responsible person who makes $20,000 a year can have a higher FICO score than a highly-paid neurosurgeon who doesn’t pay bills on time. So don’t ever think your wages will hold you back from attaining a high score. If you follow money expert Clark Howard’s rules and use your cards responsibly, which means keeping a low balance and paying the bill in full and on time, you can build a great score.
A low income can prevent you from being approved for certain credit cards. It can also result in a lower initial credit limit. But focus on maintaining a high score, and you’ll have plenty of credit card offers to consider.
2. Thinking That, Since My Husband/Wife/Partner Has Great Credit, I Do Too
The truth: You do not have a joint credit report or a combined FICO score.
This one has a lot of layers, so bear with me. As a couple, you don’t have a shared history that results in a single credit report. If you have joint accounts, you’ll see them listed on your individual credit reports.
Likewise, you have your own FICO score and your significant other has his or her own FICO score. But there are ways that the two of you can impact each other’s scores. For instance, if you have a joint credit card account, then it’s essential that you both handle credit responsibly.
If one of you gets sloppy with bill-paying activities and a late payment shows up on your credit reports, it can bring down both of your scores. The reverse is also true. If you are both on top of things, then your individual scores get stronger.
On the upside, two great FICO scores can help you when you apply for a mortgage or other loan together. So yes, you have the potential to be stronger together but only if you’ve each built a great credit history.
3. Viewing a Free Score From a Website Is the Same as a FICO Score
The truth: No, the free scores provided by websites are not FICO scores.
Sometimes I get emails from folks who think they have a great FICO score. Sadly, I have to tell them that the score they’re talking about is not a FICO score. Websites that offer free credit scores pull your information from one or more of the major credit bureaus. The score you’ll see might be a version of a VantageScore or some other type of credit score.
These scores do have value. You’ll often get category “grades” along with advice on how to improve in certain areas. For example, if you get a “C” in payment history, that’s the area you need to clean up.
But many credit card issuers are now showing a credit score on your card statement each month. Some of these aren’t real FICO scores, but they’re still helpful. If you aren’t sure what credit score you’re viewing, ask your card issuer.
About 90% of lenders use a version of the FICO score when considering applications for credit. So it’s a good idea to check it occasionally and see where you stand.
4. Thinking You Don’t Really Need a Credit Score
The truth: A bad credit score can result in higher costs in other areas of your life. The total absence of a score (there’s no zero in FICO-world) makes you look risky to anyone viewing your credit report.
Life really isn’t fair. You’d think that not using credit would make you look totally responsible. Instead, it looks like you can’t get credit.
Credit reports are sometimes viewed by folks who aren’t vetting you for a credit card or a mortgage. It’s becoming more common for employers to check the credit reports of job applicants.
Know that your credit report doesn’t show your credit score. But a score is calculated based on the contents of your report. If you have no score (or a bad score), the details of the credit report will convey this.
Other reasons for needing credit? Insurance companies look at specialized versions of credit scores when determining your premiums. Those with higher credit scores usually get lower premiums.
Also, if you need to rent an apartment, and you have bad credit or no credit, you may pay a higher security deposit; the same goes for deposits for your utilities. It also helps to have good credit when you apply for a checking account so you can get a debit card.
And what if you want to buy a house? It’s very difficult to do so without getting a mortgage at a good rate. If you’ve amassed a large amount of cash that you can plunk down at the bank, then you’ll be fine. But for most people, that’s a tall order.