Three common myths about credit scoringSherene Costanzocredit scores, FICO, factors
Are you aware of some of the most common credit score myths? Are
you giving your clients the most accurate facts about their credit
scores? There is so much that is unknown about how credit scores
are calculated that it can be a confusing topic. Everyone seems to
be discussing what can increase or decrease the credit score. It is
important for professionals in the mortgage industry to understand
how credit scoring works in order to provide clients with the best
possible financing available. Several credit-scoring myths are
floating around. Getting the facts can avoid setbacks and have your
clients on their way to better credit scores.
Myth 1: Closing accounts will increase your credit
score
This is not necessarily true. Yes, it is true that having too many
new credit accounts open can hurt your score. However, closing
accounts will not help your credit score and may actually lower it!
The damage to the credit score is done at the time of opening the
accounts and closing them does not reverse the effects. Credit
scoring models actually measure the ratio of your outstanding
balances to the amount of your available credit. When you close
credit accounts with available credit, your available credit
becomes smaller, which calculates a higher percentage of available
credit in use. This can actually lower your credit score. For
example:
Before closing accounts Total balances = $5,000 Total
credit limits = $20,000
The percentage of credit in use is 25 percent.
After closing accounts Total balances = $5,000 Total
credit limits = $5,000
The percentage of credit in use is 100 percent.
You should always try to keep this percentage below 40 percent.
You may pay down your total balances and close credit accounts
simultaneously in order to keep the percentage low. The credit
scoring formulas also measure the length of your credit history.
Closing accounts can actually cause your credit history to appear
shorter than it actually is which definitely will not help your
credit score and may actually hurt it. Also, remember that every
situation is unique, so if you have had problems with managing your
credit, closing accounts may be necessary for long-term benefits,
and you may have to take the credit score decrease now in order to
protect your future credit rating. If you are currently processing
a loan, some lenders look at other factors in addition to your
credit scores. The lender may suggest that you close some credit
accounts before extending credit to you. Closing accounts, most
likely, will not help your credit score; however, it may get you
the loan approval you are looking for.
Now, it is true that opening too many new accounts can hurt your
credit score. Credit scoring models do consider how many recent
inquiries are on a credit report. Opening several new accounts may
be a signal that one is having trouble obtaining credit or one may
be overextending themselves. It is important to be selective when
applying for credit so that you keep your inquiries at a minimum.
When shopping for home or financing a car, only allow lenders to
pull your credit reports only when you are ready and serious about
the purchase. When shopping around for best rates, move rather
quickly, staying within a time-frame of 30 days or less.
Myth 2: Checking your credit report and score will
actually decrease your score
This statement does not distinguish the method by which your credit
report was obtained. Every time your credit is pulled, an inquiry
is created on the report. Some of these inquiries may impact the
score, but others have no affect at all.
Hard inquiries
Any time you allow a third party such as a creditor or lender to
pull your credit through their sources, a hard inquiry is reported
on your credit report. This type of inquiry may impact the score,
especially if there are several inquiries over an extended period
of time.
Soft inquiries
Some of your existing creditors check your credit occasionally to
evaluate credit standing. They may use this information to offer
promotions or even to change the existing terms on an account.
These inquiries do not affect the credit score.
Personal inquiries
When you personally look at your own credit reports and scores,
using the three major credit bureaus (Experian, Equifax and
Transunion), your score will not change. Actually, it is extremely
important for you to check your credit frequently for identity
theft and inaccuracies. Correcting any inaccuracies can maximize
your score potential.
Myth 3: There is only one FICO score
There are three major credit bureaus, Experian, Equifax and
TransUnion. All three of these bureaus are separate entities and do
not share any information. Creditors may report to one bureau or
all three bureaus, which could cause each of your three reports to
contain different information. Each of these three bureaus offer a
credit score based on your credit report with that bureau. This
means you have three credit files and three credit scores
available. Most lenders and creditors will use the middle score, so
it is important for you to pull all three of your credit reports.
Monitoring all three reports is significant for improving or
maintaining excellent credit scores as well as preventing identity
theft.
It is extremely important for mortgage professionals to stress
the importance of credit to their clients. Knowing the facts allows
you to provide your clients with useful information about their
credit. It is almost impossible to predict how much one particular
factor of a credit report affects the credit score, though
manipulating the appropriate factors allows for a better chance of
increasing the credit score. Paying bills on time, keeping credit
balances low and refraining from frequently applying for new credit
is the best way to boost ones score over time. You may also refer
your client to a credit consulting company for a more detailed
credit analysis that can provide them with the information,
education and advice necessary for improving and maintaining
excellent credit now and in the future.
Sherene Costanzo is the vice president of Credit Consultants
Inc. She can be reached at (888) 522-7007 or e-mail
[email protected].
