Why Your Credit Score Matters
As loans and credit have become increasingly hard to come by, your credit score is more important than ever. Credit scores determine whether you can finance a car or a house, get an apartment and possibly whether you will be hired for your next job. If you do qualify for a loan, your score will determine how much interest you’ll pay. And, insurance companies, cable companies and even utility providers use your credit score to determine the rates or deposit amounts to charge you.
But, like many important things in life, credit scores are often misunderstood. Many of us believe popular untruths about credit scores and how they work, when knowing the truth could help us better boost or protect our scores. Here are seven common myths about credit scores and the real story behind them.
You can check your credit once per year without hurting your score, says Kimberly Foss, certified financial planner and founder of Empyrion Wealth Management in Roseville, Calif. Checking your own score is a “soft” inquiry and does not affect your score, but when lenders and others check your score, those are “hard” inquiries and can affect the numbers.
For soft inquiries, Foss recommends visiting AnnualCreditReport.com, a government-run site that provides a no-cost credit report (and your credit score from one of the three credit reporting agencies for a small fee) once per year.
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While hard inquiries are sometimes necessary, try to keep them within a 30-day period, Foss says. When she was shopping for a home mortgage, she had various lenders checking her credit score and, because her search lasted more than 30 days, they updated her credit information every month. Those multiple credit checks over a longer period negatively affected her score, Foss says.
Actually, it’s legal for an employer to pull a credit report on a job applicant or employee, but they do have to have the applicant’s permission, Foss says. Employers that most often review credit reports before hiring are those in fields like banking, finance and government agencies, where employees may have access to large amounts of money or sensitive information.
While reviewing a prospective employer’s credit report is perfectly okay, “It is illegal for credit scores to be used as a tool for screening potential employees,” Foss says. The credit score will be included on a credit report, but rather than focusing on that number, employers are supposed to be looking for financial habits or failings that could affect an applicant’s work.
As a financial industry employer, Foss regularly reviews applicants’ credit reports before hiring, but instead of looking at the credit score, she says, “I’m looking at the credibility of the person. I’m really looking at whether they have defaults or foreclosures, not whether they have a low credit score.”
Foss says she is regularly surprised by the number of young people who say they don’t worry about their credit scores because their fiancés or spouses “are good with money.” That reasoning is flawed because you don’t automatically take on your spouse’s credit score when you get married. “You have credit together, but you also have your own credit score,” Foss says.
Even if you and your spouse share the same last name, you each have your own credit score, says Andrew Housser, CEO of Freedom Financial Network. “Each person needs to obtain his or her own credit reports, review for accuracy regularly and correct errors on his or her own credit report.”
Foss cautions against listing only one spouse’s name on all credit documentation, as both partners need to build their credit and maintain a strong score. “It’s dangerous to avoid using your credit or keeping up with your score,” she says. “You don’t want to get divorced or widowed and have no credit.” Foss says she frequently speaks with clients who are recently single again and are unable to obtain a mortgage or other credit because all the credit used during their marriages was in their former spouse’s name. Suddenly they must start at the bottom again, rebuilding their own credit.
Suppose you find an error after requesting your free annual credit report. Maybe your name appears with the wrong middle initial, leaving you responsible for debt owed by someone else. Or, payment dates have been entered inaccurately, making it appear as though you have made late payments. Whatever the error is, many people believe that all they need to do is call the credit bureau and report the error, but that’s not true.
“Just because you let them know there’s an error, they won’t investigate it,” Foss says. “It’s your responsibility to get all the facts in writing, send it to all three credit bureaus and follow up to make sure the error is corrected.” Even if the error only appears on one report, Foss notes that it’s essential to send all the documentation to all three credit bureaus to make sure the error is removed from your credit history. And, keep following up until it’s gone.
If an error leads to calls from collectors, that can affect your credit as well. Typically, once a creditor sends your account to collections, that will stay on your credit report for seven years. When you alert the credit bureaus about the error in your report, remember to also alert them to any actions by collection agencies that may have been associated with the error so that consequence can be wiped from your report as well.
The Credit Card Accountability, Responsibility and Disclosure (CARD) Act, which passed in 2009, helped ease penalty fees for late or missed payments, but that doesn’t mean those late payments aren’t affecting your credit score.
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“Some people mistakenly thought that [the CARD Act] relaxed the impact of late payments on credit scores,” Housser says. “In reality, CARD has helped only with penalty fees for late or missed payments. Before, these fees were about $39; the new law limits late fees to $25 in most cases.”
Even though the fees are lower, “late payments are still late payments,” Housser says. “They do damage your credit score.” In fact, on-time payments are the most important factor in building good credit, as they account for 35 percent of your credit score.
While credit agencies rely on your past payment history to gauge how you will do in the future, you don’t have to maintain unpaid balances to show you have a credit history. If you want to build credit by using a credit card, Housser suggests charging something each month and paying it off in full and on time. “This is different from carrying a balance month to month and paying the interest and fees that go with that,” Housser says. Just remember to keep your monthly charges below 30 percent of your available credit. (In other words, if your credit limit is $1,500, don’t swipe your card for more than $500.)
If you don’t want to add expenses to your monthly budget, pay one of your regular bills via credit card. That way, you’re building credit without spending money you wouldn’t normally.
A major event such as a bankruptcy or foreclosure isn’t desirable, but it doesn’t mark the end of your life as a credit user. A bankruptcy filing can remain on your credit report for up to 10 years, and a foreclosure for seven years.
“Creditors can gauge whether you are a good risk to do business with by how well you handle your finances post-bankruptcy,” Housser says. “While it can take years of responsible spending habits to get a good credit profile back to good health, it is not impossible.” Those who succeed learn to address the issues that caused problems in the past, pay bills on time and closely follow the plan ordered by bankruptcy court.
While a foreclosure will cause your credit score to drop sharply, usually by more than 100 points, “a foreclosure is a single negative item,” Housser says. “If you keep this item isolated, it will be much less damaging to your credit score than if you had a foreclosure in addition to defaulting on other credit obligations.”
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