Top 5 Credit Scoring Fallacies
Credit scores have come a long way since appearing on the financial scene in the 1960s. As a way to judge the financial viability of a potential applicant, credit scores, from an objective view point at least, took the guess work out of the lending decision making process. What mortgage brokers, auto dealers and bank officers soon found out was that these three digits provided an effective measure of dealing with the risk of default. From the very beginning credit scoring became mystery, a kind of unprovable paradox only known to a small esoteric world of financial geeks. From a pure financial reference frame of mind (i.e., for fear they’d lose their competitive edge) it made sense to guard the inner workings of the credit scoring models. FICO indeed held a virtual monopoly on the system. For better or worse, the system today has vastly changed. Remember E-Loan? A pioneer of sought, the lending website boldly went where no other company had gone before, challenging the hegemony that Fair Isaac had largely created in regards its credit scoring model. Finally, in the year 2003, Congress stepped-in, putting an end to FICO’s monkey business about keeping the credit scores a mystery to the general public. However, this hasn’t stopped some loan officers and lenders of credit from perpetuating a number of fallacies in regard to credit scores—even in spite all the knowledge we have of credit scores. Here are five such scoring fallacies:
Fallacy #5: Closing Credit Accounts Will Help Improve Your Score…
Have you ever been told that you have “too many open accounts?” Perhaps you’re thinking that you can remedy this problem by closing an account or two? Think again. Closing accounts of any kind are dangerous for the following two main reasons:
1) Closing accounts can make your credit history look younger than it really is. Your credit score factors in the age of your oldest account and the average age of all your accounts. So closing accounts, especially accounts with the most age, is never a good idea.
2) Closing accounts reduces the total credit available to you, making your credit utilization ratio rise exponentially. Remember: FICO formula measures the gap between the credit you use and your total credit limits. Simply put, the wider the gap, the better it is for scoring purposes.
Fallacy #4 Lowering Your Limits, Can Improve Your Score…
As perpetuated by the mortgage industry perhaps, this idea delves from the foolish notion that somehow requesting that you lower your available credit makes you a responsible human being, thus appearing less risky to lenders. You might be a responsible in the eyes of a human being; however, in the eyes of FICO, you’re not—could even be considered a fool for buying into this fallacy. Credit lesson number one: FICO is a formula and is only designed to read code. In fact, when it comes to FICO scoring model, any attempt at narrowing the gap between the credit you use and the credit you have available, is look upon in an unfavorable manner.
Fallacy #3 Checking Your Own Credit Report Can Hurt Your Score…
The silliest of all the fallacies is the very idea that you can hurt your score by checking your own credit. It’s just the opposite really. Most financial experts encourage you to check your credit report and score on a regular basis, making sure everything is in order and there are no erroneous information affecting your score.
Fallacy #2 Shopping Around for the Best Rates Can Hurt Your Score…
A hard inquiry can be devastating to your FICO score. FICO and the many other scoring models on the market are vastly aware that smart and savvy consumers want to shop around for the best possible rates, especially in regards to cars and homes. For this particular reason, FICO will generate one hard inquiry within a 14 day period. Moreover, any inquiries made in the 30 days before the score changes are simply ignored. (Remember: as long as you confirm your rate-shopping to a two-week period, you should be perfectly find.)
Fallacy #1 Getting a Good Credit Score Means Not Using Credit…
There are now many financial gurus who praise the benefits to living a debt free life. However, for the vast majority of the general public, this approach just isn’t likely—it can even be a detriment to your overall financial health. Here’s how: The credit scoring formula is designed to judge how well you handle credit over a period of time; therefore, if you never use credit, how are you going to even have the sufficient amount of information to be assessed a score?
Certainly having too much debt is never a wise financial decision either, but not having any credit at all, isn’t the better alternative. Credit is a fact of life. Whenever the credit market freezes up, as it did in the 2007-2009 economic downturn, the entire U.S. economy can virtually come to a standstill. Notwithstanding, true financial independence comes from practicing what's called credit and debt due diligence, including knowing when to use credit and when not to.
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