Credit Score Misconceptions

Credit scores are a funny thing.  Even when you understand how they work, they still seem odd.  Your score can even go down by making a decision that you think is right!

Prepare for credit score enlightenment!

Paying a debt off early.

Let's say you take out a loan to make a big purchase.  You're making plenty of money to easily make your payments on time, and are able to make larger payments than needed each month.  You pay your loan off early and are feeling a great deal of satisfaction.  But a few months later, a lender checks your score, and it has gone down since you paid off your loan!  Why does this happen?

You can look at it two ways.  First, lenders look for a long track record of on-time payments.  Lenders and credit companies want to see that you can appropriately manage your expenses month to month.  Another reason for this is later in time, when you're not making payments for an extended period of time, it may look like you're no longer in a situation to be making any payments.  Lastly, think about it: if you pay off a loan early, that lender is no longer making any interest off of you...ouch.

Closing an account.

It is a common misconception that closing a credit card account is a positive step toward increasing your credit score.  Closing a credit card account will not increase your score.  If you're not in over your head in debt, there are two huge reasons not to close your account:

• In most cases, information on your credit report remains there for a certain time period after the account's Date of Last Activity or "DLA" (last time the account was used).  The DLA updates every month, so if the account remains active, it has no chance of being removed from your credit report.  The idea behind this is simple, lenders and credit companies want you to have an impressive credit history.  Here's an easy way to understand this:  Let's say that you made straight A's in school, but a few years later, that perfect record is permanently deleted.  Would you want that history deleted?  No!  If you also had a perfect record of making your payments on time, you don't want this erased either!

• The sum of your credit cards has something called Revolving Utilization, which is your "debt-to-limit" ratio.  If you have a card with a limit of $2,000 and a balance of $1,000, your utilization is 50%.  Now lets say you have a second account open with a $2,000 limit but a balance of $0.  This means you have a $4,000 limit total, but you're only using 25% of it.  If you close the second account, you're back up to 50%.  The higher the percentage, the lower your score.

Excessive credit report inquiries.

Believe it or not, having your credit report checked can cause it to lower.  Every time you fill out a credit application, you give the lender permission to access your report.  When they access your report they post what is called an inquiry, which is a record of who pulled your credit report and on what date.  Laws require that this inquiry remain on the report for 24 months.  Inquiries account for 10% of your credit score!

Inquiries are used to determine whether or not someone is shopping for credit.  It is a statistical fact that consumers who have more inquiries are higher credit risks than those with fewer.

 You might also use a credit reporting website, like the ones you see advertised on TV, to check your score yourself.  This also counts as an inquiry and you should be extra cautious of using these companies.  To start, most of the time checking your score with these sites is not really free, there's a hidden cost.  Also, many of these sites do not display your FICO score, which is the credit scale most widely used by lenders in the U.S.

What's next?

Credit is tricky...but you need good credit to achieve many wants and needs throughout your life.  I'm here to help, but we have a lot left to cover, so STAY TUNED!

I'm tired of typing "credit"...

Rob Cartwright

**Helpful Links**

• The ABCs of Building Credit. Vantage Credit Union
• www.Credit.com