When I started my blog – to be quite honest with you – I wasn’t the most knowledgeable when it came to credit scores. Which I guess isn’t surprising, considering how confusing [and deceiving] the whole credit score rigmarole can be!
Fortunately, I know quite a bit about them now. What follows are the top 5 misconceptions I hear on my forum about credit scores.
1. When you buy a score, you’re getting the real deal
According to FICO.com’s about us page, their score is used by “90 of the 100 largest financial institutions in the U.S., and all the 100 largest U.S. credit card issuers.” In other words, if you apply for a credit card, mortgage or loan, you can bet the creditor will be looking at your FICO. Therefore, if you buy your score you obviously want your FICO, right?
Well unfortunately most places that sell credit scores are not selling FICO. In fact there are only two websites – MyFICO.com and Equifax.com – that sell FICO scores to directly to consumers. All the other guys out there sell other types of scores which are either (a) not used by lenders at all, or (b) only used by a very small minority of lenders.
For example, we all know those commercials for that so-called “free credit score” website, right? Well right smack dab on their homepage, it says this in the fine print:
“Calculated on the PLUS Score model, your Experian Credit Score indicates your relative credit risk level for educational purposes and is not the score used by lenders.”
2. Using business credit cards can help build your business credit score
Many of us in the blogging world are small business owners. Take myself as an example; even though I’m just a one-man operation, I operate my forum under a one-member LLC for tax and liability reasons. But blogger or not, many Americans have small businesses. They may think applying for a business card is a good way to build up credit for their company, but that’s not always the case!
As it turns out, many card issuers do not report business cards to the major business credit bureaus (Dun & Bradstreet, Experian Business, Equifax Business). Now don’t get me wrong… if you flake on paying the bill, the account will be reported as delinquent on your personal credit file (under your SSN). But delinquencies aside, many banks simply have a policy of not reporting business accounts as long as they’re in good standing.
Therefore if your purpose of getting a card is to work on your business credit score, check with the issuing bank to make sure they will be reporting accounts. As much as I love my AmEx Gold Business card, it is utterly useless for credit purposes since American Express does not report any of their small business cards. Those which do report include Capital One and Chase business credit. I’ve also heard that some from Citi are reported, too.
3. Having credit card balances is good for your score
I can’t even tell you how many times I’ve heard from someone trying to build (or-rebuild) their credit and they say something like “I always keep a balance on my card to help my score.”
If you’re doing that, the only one you’re helping is the bank, by boosting their profits with your interest payments. Carrying a balance will not help your score.
When you get your bill each month, there is a “total balance” figure (the total amount of money you owe). That is what’s usually reported. So even if you pay off 100% of it, the spending activity on your account is still being sent to the credit bureaus.
That being said, I should point out that banks don’t always report the amount from your cycle’s closing date. Some banks report all accounts on a specific date of the month (say, the 15th) and whatever your balance happens to be on that day, that’s the amount that gets reported. But either way, the lesson is the same – there’s no good reason to not be paying off your debt on credit cards (if you use them for carrying balances).
4. High credit utilization on one account is OK
Your Credit Utilization Rate (CUR) is the percentage of your limit which you are using. For example, if you have a $10,000 limit and your card had $1,000 in spending on it… that would be a 10% CUR.
There are actually two misnomers here if we break it down. First of all, high credit utilization is bad. If you think using 40%, 50%, or more is going to help your score, you’re sorely mistaken. It can actually hurt your FICO, because it makes you look overextended and therefore, a higher lending risk.
Secondly, FICO looks at two types of CUR (a) the utilization across all accounts, and (b) the utilization on a per account basis. Since their formula is secret, no one knows exactly how they weigh each. But what we do know is that since accounts are measured individually, it’s bad even if you just have one account with a high CUR.
Also for the record, if you want the absolute best score possible follow the 0-9% rule. That being said, I regularly go up to 15% or 20% on some cards and have a 790 FICO (which is great considering my age) so even if you go past 9% once in a while, it won’t be the end of the world.
5. You don’t need loans – OR – you don’t need cards
A few years ago FICO changed their formula to put further emphasis on having different kinds of credit. It used to be you could get a stellar score just by having a bunch of credit cards, but not anymore.
Now, you need to have both installment loans (auto/student/mortgage) and revolving credit lines (credit cards) if you really want a top-notch score. That’s not to say you can’t crack the mid to high 700’s by only having one category, but if you want to be among the best, then you need to have a history of both types.
This is especially true for mortgages nowadays. If you apply for one and only have a history of using credit cards, then the lender won’t look too favorably upon you (they would like to see you using installment loans too, since that’s what a mortgage is).
Carrie loathes having to take out loans and I feel the exact same way! However, I would like to buy a house someday (with a reasonable mortgage) and since I didn’t go to college, I have no student or other forms of installment loans on my credit record.
For that reason when I bought my car, I took out a loan through a credit union even though I had the savings to pay for it. The amount was small (it was a 5 year old car) and the APR was low (3.99%) which for me made sense if it means I will get a better rate on a mortgage if and when I buy my first home.