Common Misconceptions About Credit Scoring

Understanding Credit Scoring
Understanding Credit Scoring

Credit scoring is a mystery to many and it even surprises us occasionally. Below are examples of common misconceptions we hear very often.

  • If I pay off my balance every month so it should show a zero balance on my credit report: Wrong! Credit card companies will usually report your ending balance on your monthly statement. So even if you pay off your credit card every month, it will not show a zero balance on credit. A bad scenario for someone’s score would be the following: Credit limit is $1,000 and the card owner charges $900 but pays off the balance once the statement is received. The card will report a $900 balance that is 90% of the credit limit and that will hurt the credit score as 30% of a credit score is balance compared to credit limits as a percentage.
  • I will lower my credit limits to make my credit report look better: Do not put your credit limits too low! Again, 30% of your score is balance compared to credit limits. For instance if you charge $1000 per month on a $10,000 limit card, the balance is 10% of the limit which is very good. On the other hand, if you lower the limit to $1500, the balance is 67% of the limit which hurts the credit score.
  • I will close my credit cards to help my credit report: Having a good mix of credit types is very important to have a great credit score. I will say this again, 30% of the score is balance compared to credit limits on revolving accounts and if someone doesn’t have any open cards, then a lot of points are being lost on a score. Most experts say that having 2 or 3 revolving accounts that report to all 3 bureaus with low balances compared to the limits is the magic number for the best score. Also a portion of the credit score is how long accounts are open so keep the lines of credit open a very long time rather than opening and then closing accounts often
  • I just got a car loan, so my credit should be good: I hate to say it, but about anyone can get a car loan no matter how bad the credit is so this is not an indication of good credit. Having an installment loan like a car loan is a good thing to have on credit as long as it is paid on time and the longer it has reported, the better. As a side note, be wary of buying a car and the dealership pulling your credit without your knowledge to many creditors. It is not uncommon for someone with marginal or sometimes good credit to have their credit pulled 10 times or more.
  • I will pay off my old collections just before applying so my credit scores will go up: Be careful here! If there are older collections with a date of last activity that is a while back and they are paid off, the credit scores can go down in the short term. So if someone has a 650 credit score which would qualify for most mortgages, wants to increase their scores a little by paying off old collections just before purchasing a home, the collections would now show paid off (if they actually update which they often don’t), but now show a date of last activity as “now”. It doesn’t make sense but the bureaus treat the collection activity like it just happened which doesnât seem right but it happens. Often it makes more sense to pay off the collections at or prior to closing following the recommendation of the loan officer.  Fair Isaac is working on potential changes to how this affects scores and maybe the other credit bureaus will make this change too.
  • I will dispute some credit accounts on my credit report so my score goes up: Lenders have caught up to the fact that when tradelines on credit reports are in dispute status, the credit score and the automated approval engines ignore those accounts. Therefore, the approval is not accurate. For instance, there could be a $5000 charged off account in dispute and we could get an approval but it would not be allowed until the dispute is removed and we repull credit and run the automated approval again.

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Written By: Russell Smith