By DREW JAFFE
Credit scores are important. They're a measure of your credit health and factor into many financial institutions' lending decisions. That's why understanding what they are, how they're calculated and how you can improve yours can be helpful. To help you in this endeavor, we've debunked some of the most common myths about credit scores.
Myth #1: You only have one credit score.
While we often talk about your credit score as though you only have one, you can actually have many. Each of the three major credit bureaus -- TransUnion, Equifax and Experian -- may calculate different scores for you depending on the information they have. There are also different ways to calculate your credit score. While FICO and VantageScore are the two most popular companies that calculate scores based on their own proprietary models, lenders and other financial institutions may use variations of the FICO or VantageScore models or even use their own models depending on the type of credit you're applying for.
You generally don't have access to all of your credit scores -- many of the scores you can see are "educational" scores, which can differ from the ones lenders use to determine your creditworthiness -- and it wouldn't be practical to check them all even if you did. Instead, try keeping track of one or two of your scores, and take note of any big changes over time. Because all your scores generally factor in similar information, a change in one score could mean a change in the others.
Myth #2: You need a perfect score to get the best rates.
A perfect credit score is not only uncommon -- less than 1 percent of Americans had a perfect 850 FICO score in 2010 -- it's unnecessary as well. VantageScore 3.0 and most FICO scores, for example, range from 300 to 850, but you may be able to get the best rates and offers with a score of 720, which is considered "excellent" by most lenders.
However, whether a lender considers your score "good" or "excellent" will often depend on the kind of credit you want. Different credit cards, for example, may require different credit scores depending on the issuer and the card's features.
Myth #3: Closing accounts will improve your credit health.
Closing your credit accounts could actually hurt your credit score for two reasons. First, since closing a card lowers your overall available credit, your credit utilization rate will increase if you carry the same amount in total balances. And as your utilization rate goes higher, your credit score could drop.
Second, closing an account might also shorten your credit history, which could lower your score. Some credit-scoring models factor in the average age of your credit accounts. If you close an older account, you might lower this average and negatively impact your score.
Myth #4: Checking your credit score will cause it to drop.
Checking your credit score on your own won't affect your score. Doing so results in a soft inquiry, which is typically the same type of inquiry performed by companies when they do employee background checks or by lenders when they preapprove you for credit card offers. That means you can check your score at Credit Karma as many times as you want without hurting it.
Generally, a credit check will only ding your score when financial institutions, other lenders or service providers look at your credit before making a decision based on your creditworthiness. This is known as a hard inquiry, and it usually only has a small effect on your credit.
Myth #5: You need to carry a balance and pay interest to build credit.
Some people believe you need to carry a balance to show lenders you're using credit, but doing so could result in you paying unnecessary interest. Instead, try focusing on paying off your balance in full every month and keeping your credit utilization rate below 30 percent. This doesn't mean you should ignore your cards though -- lenders like to see that you're using at least some credit and managing it responsibly, so keeping your utilization rate above 0 percent (but as low as possible) is also recommended.
Luckily, you can both pay off your balance in full every month and have a rate above 0 percent. One way to do this is by finding out when your lender reports to the credit bureaus and maintaining a reasonable balance on those dates.
To give yourself the best shot at getting that loan or credit card you've always wanted, try keeping your balances low, making your payments on time and keeping your older accounts open. But don't worry if you slip up now and then -- you don't need a perfect score to get the best financial products.
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