Wondering about your credit score and can’t tell what’s true or a myth? The average credit score in the United States is 698, based on VantageScore® data from February 2021. And, this is considered in the good range. Almost all Americans over the age of 18 owe some form of debt. During the third quarter of 2020, U.S. household debt surged to $14.35 trillion.
So, what seems to cause this rise in credit card debt?
Among many things, with credit scores, credit history, credit utilization, credit reports, annual percentage rate, grace periods, and debt, there are a lot of misunderstandings, misrepresentations, run-of-the-mill theories, and myths.
In this article, we’ll decipher credit myths and truths.
Common Credit Terms
It is of great importance that you familiarize yourself with the common credit terms used in the credit industry.
Here are some common credit terms often used:
1. Credit score
A numerical, three-digit rating that symbolizes your creditworthiness.
Scores can range anywhere from 300 to 850, and the higher your score is, the better you look in the eyes of potential lenders.
Lenders will feel confident in lending you a larger sum of money, knowing that you are able to pay in a timely manner.
2. Credit report
Think of it this way: your credit report acts as your financial resume; it speaks of your financial health to potential lenders and creditors.
Moreover, your credit report is a detailed document of your credit activity and credit history – not a myth.
Not only that, the report contains personal information, such as your address, phone number, and social security number.
As time goes by, additional information will be added by credit bureaus to your credit report.
The additional information comprises the companies that have offered your credit and/or loans, as well as the loan amounts, credit limits, and your payment history.
3. Credit history
As mentioned previously, listed on your credit report is your credit history. This is more like your web browsing history.
Throughout your adult life, your credit history reveals how you’ve handled your credit – this is not a myth! Any run-ins with debt collectors or bankruptcies are indicated in the report.
4. Annual Percentage Rate (APR)
Sometimes confused with an interest rate, the Annual Percentage Rate is almost always higher than the interest rate.
Not only does the Annual Percentage Rate include the interest expense on the loan, but also all fees and other costs concerned with obtaining the loan.
Fees can include broker fees, rebates, closing costs, and discount points.
Finding the best deal
In some cases, the lender may also offer a special deal offering a rebate on a portion of your interest expense.
If you’re comparing two loans to find the best value, choose the lender offering the lowest nominal rate. This is because the majority of the loan amount is financed at a lower interest rate.
Two lenders, same deal but different Annual Percentage Rates
Another confusing situation for borrowers is when the nominal rate and monthly payments are the same, but the annual percentage rates differ.
In this example, there are two lenders offering the same deal, but only the annual percentage rates are different.
So what should you do?
In a scenario like this, the lender offering a better deal is the one with the lower APR. Also, they require fewer upfront fees.
Do exercise caution when annual percentage rates are used. The lender will usually spread out the servicing costs in the annual percentage rates throughout the complete loan cycle.
The Annual Percentage Rate never lies
To find the actual cost of financing, pay attention to the annual percentage rate when determining which loan provider to borrow money from.
You get a clear picture of the entire borrowing cost because the annual percentage rate considers other costs connected with obtaining a loan, especially a mortgage.
It is important that you check with your creditor to make sure they properly brief you on each one. Having a good credit score can lower your annual percentage rate – not a myth.
5. Grace period
This refers to the time period automatically granted to you. The borrower will not have to pay any amount to the lender or towards the loan.
Keep in mind that as long as you pay the balance in full by the due date, you will not be charged interest.
Not all credit card companies provide grace periods. You should check with your credit card provider to be careful that it is clearly represented.
6. Credit Utilization
One of the biggest factors in your credit score is your credit utilization rate.
Usually computed as a percentage, credit utilization is your credit balance divided by your credit limit multiplied by a hundred.
For example, you may be given $1,000 a month, but only use $250 of it. That would mean your utilization rate would be 25%.
How utilization affects your credit score
An important factor in your credit score is your credit utilization rate. Thus, having a high utilization rate could potentially lower your credit score and vice-versa.
While being aware of these terms and creating a good credit score is financially essential, you need to know what makes the score go up or down.
There are several common myths about what affects your credit score.
With credit, it’s tricky to discern credit fact from credit myth. Things can get really complicated, especially if you are new to the realm of credit.
Credit Fact or Myth?
In this section, we will dissect the following credit facts and myths. The goal is for you to distinguish fact from myth, hoping this will help free you from debt or avoid it altogether.
1. Your credit score is low because you don’t have a college degree.
This credit myth is simply not true. Education level is irrelevant in credit scores. It is not part of the credit report—only debt information is.
The same goes for demographic information. Your age and where you were born have no bearing on your credit scoring.
Lenders and creditors are more concerned with your ability to pay off a loan, so they focus on your history of paying bills.
Equal Credit Opportunity Act
A creditor’s scoring system forbids credit discrimination on the account of race, color, religion, national origin, sex, marital status, or age as factors as stated under the Equal Credit Opportunity Act.
Credit reports don’t include information such as profession, sexual orientation, or disabilities.
As long as it’s not on your credit report, it won’t affect your credit score.
What is included in a credit report?
The data included in credit reports is usually debt-related information. You have personal identifying information, credit account information, inquiry information, bankruptcies, and collections accounts.
We have things that will not be in a credit report — such as income, investments, assets specified as stocks or bonds.
Also, savings accounts, checking accounts, certificates of deposit, or other non-debt banking relationships are not included.
2. Credit bureaus do not have the same information.
This is not a credit myth – it’s a fact. There are three main credit bureaus—Equifax, Experian, and TransUnion.
Each credit bureau has its own method of ascertaining your score. This explains why your score can vary across bureaus.
Do note that lenders and creditors can voluntarily choose to report to any or all of them. They can also release updates of your credit report on different dates.
So what can you do?
Have a list and make sure you are tracking your expenses and where they are coming from.
Be specific and note your expenses. Identify if you’ve paid for it in cash, debit, or credit.
It is also good practice to continue paying on time and ensure your credit reports are free of error.
3. There are different credit scoring models.
This is not a credit myth, it’s the truth. As alluded to in the previous fact, each credit bureau has its own formula for checking your score.
What is the purpose of your Credit Score?
Credit scores are there to measure how financially stable you are. They are also there to determine how capable you are of paying back debt.
In the credit marketplace, there are thousands of scoring models a company can implement, depending on the situation.
It is critical that you know the types of credit scores used in the industry.
Understanding the Two Major Credit Scores and others
You could have different credit scores. For example, lenders and other creditors could check your score for various reasons.
Several factors come into play, such as the computer systems used by each company, which can be disparate to work with a particular arrangement.
Taking into consideration the different credit details examined in each type of score framework, an excellent score in one credit bureau may only be considered good for another.
The credit score methods can be classified into three major types: FICO, VantageScore, and other credit scores.
Established in 1956, the Fair Isaac Corporation (FICO) is a commonly used scoring method. FICO scores are based on the type of loan a consumer is applying for. They can also be tailored for customer-specific needs.
FICO scores have updated their formulas over the years, which explains why so many lenders use different FICO score versions.
FICO Score 9, which was released in 2014, now includes rental payment history and aims to reduce the negative impact of unpaid medical accounts and paid third-party collections with its updated system.
In 2006, VantageScore revealed its scoring method through Equifax, Experian and TransUnion as an alternative to the FICO Score.
This was done in order to help more people qualify for a credit score.
Four separate methods of the VantageScore model were launched over the years: VantageScore 1.0 in 2006, 2.0 in 2010, 3.0 in 2013, and then 4.0 in 2017.
Although there are newer VantageScore methods, many creditors and individuals still use the 3.0 model to track credit history or acknowledge creditworthiness.
VantageScore ranges may vary depending on the method used. For example, a VantageScore 2.0 has a 501 to 990 credit score range, while the 3.0 and 4.0 versions range from 300 to 850.
Other Types of Credit Scores
Apart from the two most commonly used credit scores, FICO and VantageScore methods aren’t the only ones out there.
Jeff Richardson, a VantageScore spokesperson, said that these custom-built scoring models use credit bureau-based risk scores as input.
Also, several large lenders use custom-built scoring methods created by in-house statisticians or external third parties.
In general, credit scores usually fall somewhere between 300 and 850. Having a score above the 670 range is considered good, while a score over 800 on this same scale is viewed as excellent. Scores that fall below 579 are seen as poor.
How Can you Check Your Credit Score?
Once a year, you can check and request copies of your credit reports from each bureau for free.
Amidst the COVID-19 pandemic, the credit industry is working to help people better manage their credit and by April 2022, you can actually get your reports weekly.
It is good to note that you only get your report and not your score when you get your free credit reports. If you want to check your actual credit score, visit credit to view your score for free, or you’ll need to buy it from the credit bureau or other service.
The Key to Understanding Your Credit Scores
Understanding your credit scores can be a challenge with several credit scores out there.
So, in order for you to stand a chance against a potential lender, focus on good credit behaviors—they’ll reflect positively on you no matter which scores they are looking at.
Here are some good credit activities that you should put into practice:
- Keep a strong credit utilization rate.
- Pay on or before your due date.
- If possible, avoid closing old accounts.
- Monitor your credit score regularly.
4. Checking your own credit report will negatively affect your score.
This is a credit myth. In fact, keeping tabs on your report will help you stay on top of things. There are actually two types of credit inquiries.
Two types of credit inquiries—What’s the difference?
Take this scenario, if you gave your lender permission to check your credit, then it is going to be reported as a hard inquiry. If you didn’t, it should be reported as a soft inquiry.
But how do you tell the difference between the two, and why do they happen? Do you know what the ramifications are for soft credit inquiries and hard credit inquiries?
How would you know whether an inquiry is going to be hard or soft before it happens?
Take this as your general guide so that you get a better footing of where you stand when making those credit inquiries.
What is a Hard Credit Inquiry?
Let’s look at what a hard credit inquiry is. Hard credit inquiries, also known as hard credit checks or hard pulls, usually take place when you apply for something.
When a lender checks your credit before giving you the green light for a loan, such as a credit card, car loan, or mortgage, you’ve applied for, that’s a hard credit inquiry.
When does a hard inquiry happen, and will it affect my credit score?
Normally, you will probably know when a hard credit inquiry takes place because you will have to give the lender consent. Also, there’s a chance it could lower your credit score.
However, it is unlikely a single hard inquiry will have a huge dent in whether you’re approved for a new card or loan.
Typically, the harm to your credit scores falls or fades away even before the inquiry drops off your credit reports for good – not a myth.
Hard credit inquiries are temporary and often stay on your credit reports for about two years, which are unlikely to have a significant impact.
Although that doesn’t sound too bad, you shouldn’t be applying for a handful of credit cards at the same time — or even within the next couple of months.
So, consider spreading out your credit card applications.
Lenders and credit card issuers might consider you a high-risk customer if they notice multiple hard inquiries during a brief span of time.
This has a greater impact on your credit scores and makes you look like you are short on cash or on the way to turning up in a lot of debt.
Why are hard credit inquiries important?
Statistics show that new applicants for credit have a higher risk than consumers who don’t. This is because when a lender pulls your credit report, there’s a high probability that your credit score will decline.
A recent study by FICO revealed that people with credit inquiries that exceeded five in the last 12 months have a higher probability of becoming 90+ days past due on a credit obligation than people with zero inquiries.
The numbers go up if you have six or more credit inquiries, which resulted in people being more likely to file for bankruptcy compared with zero-inquiry consumers.
The reason lenders and other companies use credit scores are to help determine the risk of doing business with you, as well as the possibility of your defaulting on any credit obligation within the next 24 months.
Your credit score could dwindle if there are signs on your credit report indicating that you’re more likely to default on a credit obligation.
Not only that, but there are also activities that increase your credit risks, such as late payments, high credit card utilization, and other derogatory credit information.
Listed below are examples of hard inquiries:
- Requests for an increase in your credit limit
- Applying for lines of credit
- Mortgage applications
- New utility applications
- Auto loan applications
- Credit card applications
- Student loan applications
- Personal loan applications
- Apartment rental applications
How Many Points Will a Hard Inquiry Cost You?
In general, a single new inquiry will lower a credit score by less than five points, as stated by FICO.
The older the inquiry becomes, the lesser impact it will have on your score, until it no longer counts at all. Once broken down, the real credit scoring process is a bit more complicated than one would expect.
Taking into consideration other components, hard credit requests don’t check about as much toward your credit score calculation.
For instance, utilizing the FICO scoring models, credit inquiries affect 10% of your credit score. Contingent on your FICO score, your payment history is worth 35% – not a credit myth!
Under the VantageScore credit scoring models, hard inquiries are much less important. VantageScore works out only 5% of your score hinging on hard inquiries.
There are no specific point values across the board when it comes to individual credit inquiries.
By way of illustration, your credit score will lower by five points if you make a new hard inquiry. Credit scoring doesn’t work like that.
In contrast, the overall number of inquiries that appear on your credit report, in addition to the age of those inquiries, is examined in a credit scoring model. Your other credit information is important as well.
Those with established credit reports will have a lesser impact on their credit score versus those with a new hard inquiry with little credit history.
What is a soft inquiry?
When an individual or company checks your credit as part of a background check, these are called soft inquiries, otherwise known as “soft credit checks” or “soft pulls”.
They normally take place when a credit card issuer checks your credit without your consent to see if you meet the requirements for specific credit card offers.
A soft inquiry may also be conducted by your employer prior to hiring you.
Other instances when a soft inquiry happens include checking your own credit or receiving an offer from a lender, like a pre-approved credit card.
As opposed to hard inquiries, soft inquiries may or may not be documented in your credit reports, subject to the discretion of the credit bureau.
They usually won’t affect your credit scores and are only visible to you when you view your credit reports. This is because soft inquiries aren’t linked to a particular application for new credit.
Soft credit inquiries won’t show up at all if a lender checks your credit report. They are only visible on consumer disclosures—credit reports that you request personally.
Here are some examples of soft inquiries:
- Personal credit checks
- Pre-approved credit offers
- Insurance applications
- Reviews on your account by current creditors
- Employment applications and verifications
How long do inquiries stay on your credit?
Nearly all credit reporting is voluntary. For instance, credit card issuers aren’t obligated to give out customer information to the credit bureaus.
Also, the inclusion of credit card accounts on credit reports isn’t required of the credit bureaus. However, in order to help the companies involved improve their bottom lines, account information is reported and included in credit reports.
On the other hand, inquiries are legally required to be disclosed when they give anyone access to your credit information.
Almost all inquiries should remain on your credit report for at least 12 months, as stated by the Fair Credit Reporting Act (FCRA).
For example, employment inquiries have to remain on your credit report for 24 months.
Normally, credit reporting agencies choose to hold on to inquiries on your credit reports for two years.
But FICO only considers hard inquiries that occurred in the last year. There is zero influence on your FICO Score once a hard inquiry is older than a year.
Yet again, VantageScore is more tolerant when it comes to inquiries. In the event a hard inquiry lowers your VantageScore credit score, it will almost always bounce back in three to four months (granted that no new negative information appears on your credit report).
Will checking my own credit scores result in a hard inquiry?
This is a credit myth. Checking your own credit is deemed a soft credit check, so it won’t have a negative effect on your scores. It is important to note that other types of credit checks could appear as either a hard or soft inquiry.
For example, providers who will often check your credit are the following: utility, cable, internet, and cellphone.
Have a hard time distinguishing whether it’s a hard or soft credit inquiry?
You can ask the company, credit card issuer, or financial institution involved to clarify any particular inquiry.
How to dispute hard credit inquiries
It is highly recommended that you check your credit reports frequently. Consider disputing any errors you find with the credit bureau, such as a hard inquiry that occurred without your permission. For further assistance, you can contact the Consumer Financial Protection Bureau (CFPB).
At the very least, this could be an indication of identity theft, as reported by Experian. Make sure you look into it and understand what’s going on.
Be mindful, hard inquiries that occur without your permission can only be disputed. Once you’ve authorized a hard inquiry, normally it could take up to two years to fall off your credit reports.
5. Will canceling my credit card improve my credit score?
The answer is no. In fact, closing your card will cause a lower credit score.
A good reason for this is that once you close your account, your total available credit goes down, resulting in your credit utilization going up.
Credit Utilization Secret Formula
A key term to remember is credit utilization. For those who aren’t familiar with the term, credit utilization is the link between your credit card balance and your credit limit.
You can use this formula to calculate your credit utilization rate: Credit Card Balance ÷ Credit Limit × 100 = Credit Utilization Rate
This will tell you how much of the credit you’re using.
Maximize Your Credit
To maximize your credit scores, you can maintain a credit utilization under 10%. Otherwise, a utilization of 30% below is adequate if you’re looking to apply for financing in the near future.
Having good credit is all about finding balance and controlling the impulse to splurge.
If you want to earn some extra cash, you can check with your credit card rewards that offer referral bonuses. Consult with your credit issuer on how to refer a friend.
Every time you refer someone for a credit card, and their application gets approved, you have a chance to earn referral bonuses, typically around $50 to $150.
To receive these kinds of bonuses, there are some requirements, but it’s a relatively straightforward way to earn extra cash (up to $500 in most cases).
6. Credit bureaus are owned and managed by the government.
Another myth debunked. Credit bureaus operate as private or commercial companies.
Although many consumers think that credit bureaus like Experian, Equifax, and TransUnion are operated or are under the thumb of the federal government, but they’re not.
Protect Your Rights
However, the federal government protects your rights.
As per the Fair Credit Reporting Act, consumers, like you, are protected from harmful credit practices while permitting insurance companies, lenders, employers, and others to use credit reports to find out credit risk.
7. Having a lot of money in the bank means you have a good credit score.
A statement that is definitely untrue. With your bank balance or the amount of income you have, credit bureaus do not consider them in your credit scoring.
What affects my credit score?
Factors that have a role in your credit score are amounts owed, payment history, credit mix, and new credit.
With that said, you need to avoid missing payments, defaulting on accounts, applying for a lot of credit in a short time, and using too much available credit.
A good rule of thumb to improve one’s credit score is to keep your credit utilization below 30%.
8. Having a lot of debt means that your credit score will be low
This is a myth. Not all debts are identical. This will depend on your situation.
For example, a credit card bill is something you can pay off sooner, while a 30-year mortgage is a long-term investment.
Sometimes, having no debt could mean that you don’t have a credit history as well.
9. Once a bad credit score, always a bad credit score.
All these can seem overwhelming and complex, but it doesn’t have to be the case. You can educate yourself and take the actions to prevent a low credit score.
We are not immune to making poor decisions. Although you can’t change the past, you can certainly take steps to improve your score.
You can reach out to your lenders. Find something that works for you. For example, you can set up an alternative payment schedule. Ignoring the situation will only add fuel to the fire.
Be responsible and practice good credit management.
10. Settling my debt will get rid of any late or missed payments.
Although this is partly true, paying off any debt will not bring down the impact of late payments or take it away from your credit report.
Normally, these negative items stay on your report for up to seven years.
The bright side is, having positive credit practices can help lessen the implications of a negative item over time.
11. I have a good credit score, so they will approve my credit application.
FALSE. Information in your credit reports and other data included on your application, such as your income, solely depends on the discretion of the lender to decide whether to grant you credit.
While a good credit score is good, each application is unique, so it’s not wise to consider a loan, credit card, or mortgage entirely established on credit scores.
Be patient in trying to build your credit scores prior to applying for credit. Your credit scores are instrumental in your financial well-being.
The chances of being approved for the financial products may increase with stronger credit. You want to have the best possible terms and rates.
Steer clear from applying for multiple credit cards within a short span of time.
Although one hard inquiry may ding a few points off your scores, several inquiries in a short amount of time may result in more damage.
An exception would be if you’re rate-shopping for a home or car, as so, then you’ll probably have a grace period to shop around.