A credit score is a mathematically derived three-digit number ranging from 300-850 that reflects your creditworthiness. It is representative of your payment history and borrowing behavior. It lets lenders determine whether you are a credit risk.
A credit high score shows that you repay your debts in time while a low number reflects a lower likelihood of timely repayment. Lenders are willing to lend larger sums for competitive interest rates in case of a high credit score, while a low credit score may mean higher interest rates and stricter terms.
Here is a list of few factors that contribute to the credit score:
Current Debt or Credit Utilization Rate
Credit Mix and Duration
Even though the credit score is an important detail, most people are not entirely aware p how this can affect their financial well-being. There are a number of misconceptions about how the score is calculated or how you can improve it.
Here are six credit score myths that most borrowers believe.
Credit Scores Change Slowly
This statement is misleading and can harm your credit score. Your credit score is a reflection of the financial decisions you made in the past and the choices you are making today. A payment default on a loan, late payments, and hard inquiries impact your score negatively. On the other hand, managing your finances sensibly and following good credit practices improves your score. Your credit score is updated periodically to reflect all such financial activity and changes accordingly.
Debit Cards build Credit Score
Your credit score is a reflection of your credit usage. There is no truth to the belief that using a debit card affects the credit score, as it does not involve any type of credit. Moreover, debit card transactions are not reported to credit scoring agencies.
Using your debit card for purchases is similar to using cash as the money is directly deducted from the bank account. Therefore, if you are trying to build a healthy credit history, it is advisable to use a credit card and pay off the bills in a timely fashion.
A Better Job Means a Better Credit Score
A better paying job is not conducive to building a better credit score. While your income is a factor that lenders take into consideration when you apply for a loan, it is separate from your credit score. Your income finds no mention in your credit report and does not impact your credit score in any way.
A good credit score is primarily dependent on your timely repayment habits, which can be ensured through a better paying job. Naturally, it will help to pay your debt faster and help in improving your creditworthiness but does not directly improve your credit score.
No Debt Means a Good Credit Score
A credit score is a reflection of how well you manage the credit available to you. Without debt, you cannot improve your credit score as there will be no credit history to impact your score. Therefore, you need to build a sufficient credit history to build your credit score. By ensuring timely repayments and following good credit practices, you can improve your score quickly.
In the case of no credit history, your credit report and credit score will be shown as NA (Not Applicable)/ NH (No History).
Closing Credit Cards Increases Credit Score
The truth is, closing your old credit card accounts can actually hurt your credit score. Since credit cards are a part of revolving credit, it reduces the amount of credit available to you and negatively impacts your credit utilization ratio.
Rather than closing the credit card, maintaining a credit utilization ratio that is less than 30% can significantly improve your credit score.
Comparison Shopping for Loans Hurts Credit Score
Every time you apply for a loan, the lender requests a hard inquiry, which can impact your credit score. However, this should not deter you from comparison shopping when you are looking for a suitable loan. Some credit score models view multiple entries within a certain time period as one, if they recognize that you are rate shopping. This is done by analyzing the line of credit applied for and the amount of loan. Most credit rating agencies let you do rate shopping for a period of 45 days. This lets you select the best loan product that suits you without hurting your credit score too much.
Myths about credit score can do more harm than good. Given the increased scope of use of credit score in today's world, it can result in missing an opportunity or having to get credit at higher interest rates. This is why it is advisable to consult an expert and do thorough research before you fall for these myths.