For individuals looking to get a new line of credit or take out a personal loan, there’s one variable that’s considered as the be-all and end-all of getting approved: credit scores. In a way, credit scores are the ultimate factor determining how your application will go. Because of their crucial importance, however, numerous credit score myths have surfaced throughout the years – some of which have been widely spread across populations and have been the source of credit score misinformation. Not only have these myths caused misunderstandings in financial institutions, but it has also led to individuals avoiding applying for credit for fear of rejection. In this article, we’ll talk about the most common myths and facts about credit scores today and debunk them with credible information from the finance industry.
Credit Score Myth #1: Requesting for your credit score will affect your score
One of the most common myths about credit scores is that once you request a credit report from an accredited credit bureau, you’re basically causing it to drop or be negatively impacted. Credit scores are solely reliant on your credit history, personal information, and financial background. Requestion personal credit reports will not affect your credit scores in any way. In fact, if you’re planning on taking out a credit line or a loan, requesting a credit report before an application is a good way to check whether all the information on the report is updated and accurate. This is especially important since negative information or inaccurate data may cause you to miss out on a credit or loan approval.
Credit Score Myth #2: Bad credit lasts forever
If you have a history of bad credit or delinquent payments, chances are these will significantly impact your credit score – especially since credit reports are going to include both your good and bad financial backgrounds. These bad credit histories will stay on your credit report and impact your reliability in the perspective of financial institutions for a significant amount of time. However, contrary to the credit repair myth, this is not permanent.
Remember that credit scores are dynamic and can be influenced by numerous factors. You can expect a poor credit history to last between seven to 10 years – especially if you have a history of bankruptcy. As your credit score recovers, there are numerous ways how to improve your credit score, including reducing the overall amount that you have in loans and repaying revolving credit. It also helps to avoid applying for multiple new lines of credit since these can negatively affect your credit score further.
Credit Score Myth #3: Your bank account balance affects your credit score
While bank accounts play a significant role in every person’s financial freedom and capabilities, your balance does not directly affect your credit score. This myth might originate from the misunderstanding that all history from formal banking will appear on your credit report. Your banking history, including deposits, withdrawals, and other bank transactions, is typically excluded from credit reports consolidated by credit bureaus – save for a few exemptions.
The rare cases which banks report delinquent bank transactions include bank overdrafts and bouncing checks. For overdrafts, this means that some banks may allow you to complete transactions through overdraft protection, even though you have insufficient funds. This, however, works as a form of credit, so banks will still need to report incidences of bank overdrafts. On the other hand, not only do bouncing checks end up in your credit report, but it can also land you in trouble with the law since it is a legitimate crime.
Credit Score Myth #4: No credit is worse than bad credit
One of the most common impediments that credit applicants encounter when getting loans and mortgages is their lack of credit. With over 53% of Filipino adults being unbanked and underserved, there’s no question that this is a significant problem for both applicants and financial institutions. This common credit myth has also caused individuals to avoid applying for personal loans and credit because of their lack of formal financial background.
However, is being underbanked worse than bad credit? Not entirely. While having no credit history can serve as a deterrent to application approvals, bad credit is much worse since it provides financial institutions with a background on your negative financial habits. From unpaid loans to delinquent payments, financial institutions are more likely to refuse a new line of credit to people who have unreliable financial capabilities. In addition, it’s easier for people who are underbanked to build a good credit score through alternative credit data than for people with a negative credit score to improve it quickly.
Credit Score Myth #5: My educational attainment affects my credit score
Credit scores don’t include your educational attainment or background, which debunks this credit score myth. Credit reports only focus on providing financial data and the most basic information about an applicant, including your name, business, revolving credit, and loans. In fact, it is also illegal for financial institutions to judge an applicant’s credibility and creditworthiness on their educational background. According to the Equal Credit Opportunity Act, financial institutions and creditors are prohibited from using a credit screening system that looks at religion, national origin, age, marital status, and educational attainment.
Credit Score Myth #6: All financial institutions use the same credit score equation
Financial institutions from all over the country do not depend on a singular credit scoring system or equation. While the credit reports that creditors use as a background are typically the same across the board, your credit score may vary from institution to institution. This means that if you get denied by a lending company due to poor credit scores, you can still be approved by another because of varying equations and factors that they may include in their screening.
Additionally, some financial companies also use alternative credit scoring systems that do not primarily focus on credit history and banking. The rise of alternative credit has helped a lot of financial institutions broaden their approach to credit applications, offering applicants a better chance of being approved even if they have a limited credit history or formal banking background.
Credit Score Myth #7: Paid-off delinquent credit card balances and loans will be removed from my credit score
Another credit score myth that a lot of people believe is that once you pay off delinquent balances, they’ll be written off or erased from your credit score. Unfortunately, this is not the case since bad credit habits or history can stay on your credit report for years on end, regardless of whether they’ve been paid off or not. While paying them off is a good move, it will not automatically mean that your credit score will quickly recover. This is why it is of utmost importance that you pay your loans, mortgages, and other lines of credit on time.
Credit Score Myth #8: Closing credit accounts helps improve credit scores
This common credit myth is one of the most damaging pieces of misinformation, with individuals observing significant decreases in their credit scores after closing credit accounts with no due reason. If you’re planning on applying for a new credit card or credit account, you might think that closing your current credit lines is the best move. In actuality, this can actually hurt your credit score more since this might hike up your credit utilization ratio, or the percentage of the credit you’re currently using versus the credit that’s available to you.
Credit companies are required to report to credit bureaus every month, so if you close your account with a balance that has more than 30% credit utilization, this can be translated into a credit score decrease. If you’re planning on closing credit accounts, ensure that all your balance is paid off and that you have a lower credit utilization.
Credit Score Myth #9: Credit repair companies can help credit scores fast
Credit repair companies are businesses that can help correct a person’s credit history. Their services typically include removing inaccurate data and erroneous information that can affect your credit score. While there are legitimate credit repair companies around the world, there are also a handful of companies that prey on individuals by proposing scams and promising results that are not achievable.
Credit repair companies generally work by checking credit reports and fixing information, but they cannot fully erase bad credit – which is what this credit repair myth claims. If they find inaccurate data, credit repair companies can submit disputes and handle back-and-forth communication with credit bureaus. If the credit bureau confirms the legitimacy of your claim, the inaccurate financial data will be permanently removed from your report. This process can take up to 6 months, so fast credit score repairs are not at all possible.
Credit Score Myth #10: Maxing out your credit card but paying on time doesn’t affect your credit score
If you have current credit accounts, chances are you’ve thought of maxing out the credit that’s amounted to you by your creditor. You’ve also probably thought that paying on time will cancel out this credit utilization since technically you’re not a delinquent payer. However, because credit scores and credit reports do not entirely revolve around payment history, maxing out credit cards can decrease your credit score due to the credit score utilization rates.
As mentioned above, credit score utilization rates present your spending habits and debt versus the credit that has been allocated to your account. Maxing it out means that you get 100% utilization rates for months on end. This negatively impacts your credit score, especially since ideal credit utilization falls between 0 to 30%. The good news though is that your credit utilization rate doesn’t permanently affect your credit score and may be improved easily by either lowering your debt or raising your credit limit.
Debunking Credit Score Myths Can Translate to Better Financial Literacy
Credit scores play significant roles in helping people achieve financial independence through new lines of credit or loans. Unfortunately, credit score myths and misinformation have impeded a significant percentage of people from pursuing applications altogether. By debunking credit score myths and educating people about the importance of having good credit scores, financial institutions can promote their services to a wider portion of the population and offer better opportunities through improved financial literacy.
For more information about alternative credit scoring, you can reach out to our team at FinScore, and we’ll help you navigate through the terrain of finance tech.