Myths and misinformation abound in the world of credit scoring. Here are some of the most common credit scoring myths, and the truth of the matter.
1: Credit scoring used for pre-employment screening
Truth: Credit scores are not and have never been used by employers for employment screening purposes. Employers don’t even have access credit scores.
Credit reports, which are different than credit scores, can be used for employment screening purposes, but only if you provide your overt permission for the report to be accessed.
The idea that credit scores are used by employers stems from the fact that the terms credit report and credit score are often used interchangeably. However, the terms are not interchangeable whatsoever since credit scores and credit reports represent two entirely different products.
Equifax, Trans Union, Experian, and even the credit bureau’s trade association have gone on the record over and over again stating that credit scores are never provided to employers.
There is no doubt that credit scores do wield a lot of power. They can affect your insurance premiums, determine your eligibility for loans, and impact your interest rates on loans. However, credit scores cannot influence an employer’s decision to offer you a job.
2: Spread balances to increase credit score
Truth: Spreading out credit card balances over multiple credit cards can actually have a negative impact upon credit scores. Credit scoring models like FICO and VantageScore use a variety of factors to determine scores.
The second most important metric in credit scoring is debt load, or the amount and type of debt on your credit obligations.
The fewer accounts you have with a balance the better it is for your credit scores. Having a credit card with a zero balance is also very likely to have a positive impact upon your credit scores since cards with zero balances have a debt-to-limit ratio of 0%. The debt-to-limit ratio is a term used to describe the relationship between your credit card balances and your credit card limits.
When it comes to credit card debt the best strategy is to never revolve balances from month to month. However, if you are already in over your head in the credit card debt department then it is best to find an effective way to pay down your credit cards rather than spread out the balances.
If you cannot afford to pay off your credit cards, a consolidation loan might be worth considering, as long as you have the discipline not to charge your credit card balances back up once you have paid them off.
3: You only have 3 credit scores
Truth: Despite what you may have heard or read you have significantly more than three credit scores. You actually have closer to 80 credit scores when you consider all of the different FICO and VantageScore credit scoring models that are commonly used by lender.
FICO alone has some 65 different credit scoring models commercially available from the three credit reporting agencies.
Credit scores exist to predict borrower risk, and different “flavors” of credit scoring models are built to help predict different types of risk. For example, insurance companies rely upon scores to help predict the risk of someone filing a claim. Lenders use credit risk scores to predict the likelihood of a consumer becoming 90 days past due on any account within the next two years.
There are also scoring models that predict the likelihood of a consumer filing bankruptcy, if a consumer will respond to a credit card offer, and the likelihood that you’ll be a profitable borrower. No one has just three credit scores.
4: Value of account age lost when credit card closed
Truth: Closing a credit card account does not cause you to lose the value for the age of the account.
Credit scoring models will still consider the age of closed accounts when calculating your credit score as long as they’re still on your credit report. Closed credit cards even continue to age after they have been closed.
It is certainly possible that closing a credit card will have a negative impact upon your credit scores, but not because closing the card has any effect on the age of the account.
The real reason closing a credit card account might lower your credit scores is because closing the account could possibly increase your debt-to-limit ratio.
The debt-to-limit ratio is the relationship between the balances on your credit cards relative to the credit limits on your open (as in “not closed”) credit cards. When you close a credit card the credit limit on that card will no longer be used to calculate your debt-to-limit ratio. Therefore, when you close a credit card your scores could go down because your debt-to-limit ratio will likely go up. That’s why it’s best to keep your credit card accounts open.
5: Credit scores reward you for debt
Truth: Credit scores significantly reward consumers who do not have any debt, especially consumers with zero credit card debt. And, credit scoring models punish consumers who have too much debt.
The idea that you need to carry a lot of debt to have good credit scores is completely false and is perpetrated by those who either don’t understand credit scoring systems or have a bone to pick with them.
This particular credit myth has become a very popular one due to the fact that many self-proclaimed “financial gurus” on TV and radio like to spread the false idea that you have to be in debt in order to have higher credit scores.
A whopping 30% of the points in FICO and VantageScore credit scores are driven from the amount of debt on credit reports. The fewer accounts you have with balances, the better it will be for your credit scores. The more debt you have and the more accounts with balances, the lower your scores will be.