Are you planning to apply for a loan soon? You are in good company. In 2020, there were 22.7 million home loan applications, according to the Consumer Financial Protection Bureau. Meanwhile, Experian says auto loans hit a record high of $1.37 trillion. So there are a lot of loans.
Your credit score and credit history are among the most important factors lenders look at when you apply for a loan or mortgage. If you’ve struggled with your finances in the past, learning more about your credit score can be daunting. But understanding your score and what’s in it is key to getting the loan you need.
There are many myths surrounding your credit score and what does or does not affect it. Let’s look at some of the most common myths and the truth behind them.
Having a credit card balance increases my credit score
This is a persistent myth around building credit. Carrying over a credit card balance from month to month can hurt your credit score and will likely cost you money in the long run, since you’re paying interest to the credit card company. credit on any balance not paid in full.
In general, people with the highest credit scores have a credit utilization rate — the total amount of credit you use compared to the amount of credit you have — by 10% or less. When your utilization rate exceeds 30%, your credit score may be negatively affected, as lenders may worry about the amount of credit you are using.
Paying off a debt quickly removes it from your credit report
Paying off revolving debt, like a credit card, can be a good plan because it improves your credit utilization rate. A history of on-time payments and responsible use of credit is generally helpful in loan applications because it shows lenders that you are using credit responsibly.
Some people think that a closed account or paid off debt quickly disappears from your credit report. In fact, if you’ve paid your debt in full and made all payments on time, credit reporting agencies could keep the account on your credit report for up to a decade.
Additionally, a history of late payments can stay on your credit report for up to seven years, and certain types of bankruptcies can stay on your report for up to 10 years. When paying off a credit card, be sure to do so responsibly. Consider setting up automatic payments so you don’t accidentally miss a payment.
You have to be rich to have a good credit score
Your bank balance and income have nothing to do with your credit score. It’s possible to have a high income and a bad credit score because you have a large balance on your credit card, made late payments, or mismanaged your finances.
Likewise, you can have an average salary and still have a high credit score. Many lenders use the FICO score, created by Fair Isaac Corp. The highest FICO score you can get is 850. Anything above 800 is generally considered excellent and can help you qualify for the best loan rates and terms.
All debts have an equal impact on your credit score
Paying off a credit card or other revolving debt can improve your credit score because it increases your credit utilization rate. Paying off installment loans, such as a car loan or mortgage, can also affect your score, but the impact is unlikely to be as great as paying off revolving debt.
So develop a strategy to help you pay off your revolving debt if you want to increase your score. Methods to achieve this include snowball or debt avalanche approaches. With the debt snowball, you first pay off your smaller debts and progress to larger ones. With the debt avalanche, you attack your debts starting with the bonds that have the highest interest rates.
Student loans don’t affect your credit score
All loans, including student loans, mortgages, car loans, medical debt, and even your utilities, are included in your credit score. Even one late payment can cause your credit score to drop, so paying your bills on time is essential.
Payment history is one of the most important factors in calculating your credit score. For example, it makes up about 35% of the composition of your FICO score. So, making payments on time is one of the most important things you can do to potentially boost your score. Develop a budget and call your lenders before you miss a payment so they can help you develop a strategy that could prevent a negative impact on your score.
Checking Your Report Hurts Your Credit Score
Checking your credit report regularly can be a great way to keep tabs on your credit profile. Checking your own report does not affect your score.
When you’re pre-approved for a loan or mortgage, it’s traditionally considered a “soft pull” since you haven’t applied for credit yet. Soft pull-ups have no impact on your score.
On the other hand, when you take the next step and submit a formal credit application, the lender will do a “hard bang” to check your credit report, which can drop your credit score by a few points. The same applies when applying for a credit card or other credit inquiries.
Be careful how many credit cards or loans you apply for, especially if you plan to buy a house or car soon. Multiple credit applications and multiple difficult applications can lower your score and set off red flags for lenders.
How much I earn affects my credit rating
Your income and job title do not affect your credit score and are not reported to credit bureaus. Lenders usually get your salary range and job title directly from you because they aren’t on your credit report and therefore don’t factor into your credit score.
Instead, your FICO credit score is made up of the following factors, from most impacting to least:
Regardless of your income, be sure to develop a budget that takes into account your needs like your mortgage or rent, food, utilities, debt repayment, and retirement savings. And try to leave room for the fun things in life, like hobbies or travel.
Using a debit card helps me build my credit rating
Debit cards are tied to a checking account and are not a form of credit, so they generally don’t impact your credit score. The money is withdrawn directly from your checking account and does not affect your available credit.
If you don’t have a credit card, applying for one and using it responsibly can be a great way to improve your credit score. Paying off the balance in full each month and making payments on time will help boost your score. If you are looking for a credit card, see the best credit cards to find the one that suits your needs.
At the end of the line
It is important to note that your credit score is just an overview of your financial life at any given time. By focusing on repay the debtincreasing your credit utilization rate and making your payments on time can help improve your credit score.
If you’re applying for a mortgage or car loan soon, check your credit score and credit report to find out what lenders will find. Then make a plan to improve your score as much as possible.
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This article 8 Credit Score Myths That Could Hurt Your Chances of Getting a Loan originally appeared on FinanceBuzz.