BETA
This is a BETA experience. You may opt-out by clicking here

More From Forbes

Edit Story

5 Costly Credit Score Myths

This article is more than 8 years old.

Credit scores dominate a large part of our personal financial lives. A good score can open the door to low interest rates on mortgages, auto loans, student loans and more. A bad score can make our lives incredibly expensive. It is no surprise that many Americans are obsessed with attaining the highest credit score. Unfortunately, there are a number of credit score myths out there. If you believe these myths, you could end up costing yourself a lot of money.

Here are five of the biggest, and costliest, myths.

1. I Need To Borrow Money To Get A Good Credit Score

Not a week goes by without someone asking me about this myth. And it just isn't true.

You do need to have activity on your credit report in order to have a credit score. And to have the best credit score, you should have activity on your credit report every month. However, you can have activity without borrowing money and paying interest.

If you have a credit card, you can pay your statement balance in full every month, and that will count as activity. If you always pay your statement balance in full, you will never pay interest.

The only people who benefit from paying interest on credit card debt are the bankers working at the credit card company.

2. I Can't Shop Around For A Lower Interest Rate

The only way to get a good deal in life is to shop for a better deal. But many people are afraid to shop around for a lower interest rate, because they are afraid it will hurt their credit score. This fear is hugely ironic. The only reason you have a good credit score is to get a lower interest rate. Yet, once people have a good credit score, they are afraid to shop around because they are afraid their score will go down.

If you are shopping for a mortgage, auto loan or student loan, you should apply to as many lenders as possible to look for the best deal. FICO has made clear that you can apply as many times as you want in a 30 day period, and it will only count as one inquiry.

If you have credit card debt and are looking for a lower interest rate, the new marketplace lenders have made it very easy to see how much you can borrow and at what interest rate. They use a soft pull, which does not impact your credit score. You can see a list of these lenders at MagnifyMoney, and interest rates start as low as 4.25% for people with the best scores, compared to average credit card interest rates near 17%.

3. If I Pay For A Collection Item, My Score Will Improve

Unfortunately, once a collection item is on your report, the damage is done. FICO has publicly admitted that paying for your collection items does not improve your score. FICO looks at whether or not you have a collection item, and how long ago that collection item appeared on your credit report. As they write on their website, "whether or not you pay your collections off is a personal decision."

It is very important to stay current on your payments. Once your account becomes seriously past due, your creditor could turn over the account to a collections agency. It is at that time that a collection item hits your credit report and does serious damage to your score.

If you had a choice between using money to bring an open credit card current or pay off a collections item, you should probably bring the open account current. I have frequently met people who work on the most delinquent accounts first, which can be a mistake.

4. I Don't Make Much Money, So I Won't Have A Good Score

Your credit score is calculated using information from credit reporting agencies. Your income is not reported to credit reporting agencies, so there is no way for your credit score to use that information.

Credit scores fundamentally answer three questions:

  • Have you made your payments on time?
  • Have you maxed out your credit cards?
  • How long have you been using credit?

People with the best scores have made their payments on time, have not used more than 20% of their available credit and have demonstrated this behavior consistently for years. The score does not take into account your income or your job.

Banks will consider your income when you apply, but that information is not part of your score. I have met too many people who think they can't get a good interest rate because they don't have a high income. If you pay your bills on time, your score is probably a lot higher than you expect.

5. I Know My Credit Score

Many people think that they have only one credit score. Unfortunately, there are hundreds of credit scores out there. FICO is the most popular, because its use is mandated in most mortgage decisions. But even FICO has many different credit scores. They have scores for mortgages, auto loans and credit cards. And they have different versions of credit scores as well.  In addition, FICO is now receiving some real competition from VantageScore. And every bank risk management department builds their own credit score.

That doesn't mean you shouldn't pay attention to your credit score. Although every credit score is a little bit different, people with excellent scores tend to be excellent everywhere. If you sign up for a free service like CreditKarma to watch your VantageScore, your goal should be a 750 score or higher. The only way you get that is by paying your bills on time and managing your credit. And if you have a good score at CreditKarma, you will probably have a good score everywhere else.