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 have surged to a record high of $1.37 trillion. So there is a lot of borrowing.
Your credit score and credit report are among the most important factors lenders look for when applying for a loan or mortgage. If you’ve struggled with your finances in the past, finding out about your credit score can be intimidating. But understanding your score and what it means is critical to getting the credit 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.
Discover 6 smart ways to pay off your debt.
Carrying a credit card balance increases my credit score
This is a persistent myth surrounding credit construction. Carrying a credit card balance month-to-month can hurt your credit score and will likely cost you money in the long run as you pay the credit card company interest on unpaid balances.
Generally, people with the highest credit scores have a credit utilization ratio – how much total credit you use compared to the credit you have available – of 10% or less. If your utilization rate rises above 30%, your credit score can be negatively impacted as lenders may be concerned about how much credit you’re using.
Paying off debt quickly removes it from your credit report
Paying off revolving debt, like a credit card, can be a good plan since it improves your loan utilization rate. A history of on-time payments and responsible use of credit is usually helpful with credit applications because it shows lenders that you are using credit responsibly.
Some people think that a closed account or a debt that has been paid off will quickly disappear from your credit report. If you’ve paid off your debt in full and made all payments on time, credit bureaus can potentially 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 some types of bankruptcies can stay on your report for up to 10 years. When paying with a credit card, make sure you do so responsibly. Consider setting up automatic payments so you don’t accidentally miss a payment.
You have to be rich to have good credit
Your account balance and income have nothing to do with your credit score. It’s possible that you have a high income and bad credit because you have a large credit card balance, late payments, or otherwise mishandled your finances.
Likewise, you can have an average salary and still get a great credit score. Many lenders use the FICO score, published by Fair Isaac Corp. was created. The highest FICO score you can achieve is 850. Anything over 800 is generally considered excellent and can help you qualify for the best lending rates and terms.
All debts equally affect your credit score
Paying off a credit card or other revolving debt could benefit your credit score as it increases your loan utilization rate. Paying off installment loans like a car loan or mortgage could also affect your score, but the impact is probably not as big as paying off revolving debt.
So develop a strategy that will help you pay off your revolving debt if you want to increase your score. Methods for this are the debt snowball or the debt avalanche approach. With the debt snowball, you first pay off your smallest debts and then get to the biggest ones. With the debt avalanche, attack your debts starting with the highest-yielding bonds.
Student loans do not affect your credit score
All credit, including student loans, mortgages, car loans, medical debt, and even your utility bills, are factored into your credit score. Even one late payment can cause your credit score to drop, so it’s important to pay your bills on time.
Payment history is one of the most important factors in calculating your credit score. For example, it makes up about 35% of your FICO score composition. So, making payments on time is one of the most important things you can do to improve your score. Develop a budget and call your lenders before you miss a payment so they can help you devise a strategy that could prevent negative impacts on your score.
Checking your report hurts your credit score
Regularly checking your credit report can be a great way to keep an eye on your credit profile. Reviewing your own report will not affect your score.
Traditionally, being pre-approved for a loan or mortgage is considered a “soft move” because you haven’t applied for credit yet. Gentle moves do not affect your score.
On the other hand, if you take the next step and make a formal loan application, the lender will do a “hard pull” to review your credit report, which may result in your credit score dropping a few points. The same applies to applying for a credit card or other loan applications.
Be careful with the number of credit cards or loans you apply for, especially if you plan to buy a home or car soon. Multiple loan applications and multiple hard deductions can lower your score and raise red flags for lenders.
How much I earn affects my credit score
Your income and job title do not affect your credit score and are not reported to the credit bureaus. Lenders will usually get your salary range and job title directly from you as they are not listed on your credit report and therefore do not factor into your credit score.
Instead, your FICO credit score is made up of the following factors, from highest to lowest:
Regardless of your income, make sure you develop a budget that takes into account your needs such as your mortgage or rent, groceries, utilities, paying off debt, and saving for retirement. And try to leave room for the finer things in life, like hobbies or travel.
Using a debit card helps build my credit score
Debit cards are tied to a checking account and are not a form of credit, so they typically don’t affect your credit score. The money is debited directly from your checking account and does not affect your available balance.
If you don’t have a credit card, applying for and using a credit card responsibly can be a great way to improve your credit score. Paying off the balance in full each month and making payments on time can improve your score. If you’re looking for a credit card, check out the best credit cards to find one that suits your needs.
It’s important to note that your credit score is just a general snapshot of your financial life at any given point in time. If you focus on paying off debt, increasing your credit utilization, and making payments on time, you can improve your credit score.
If you’re about to apply for a mortgage or car loan, check your credit score and credit report to see what lenders will find. Then make a plan to improve your score as much as possible.
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This article 8 Myths About Credit Scores That Could Hurt Your Chances of Getting a Loan originally appeared on FinanceBuzz.