Understanding how credit works is crucial to building and maintaining a healthy score. It’s sometimes difficult to know the facts when lots of outdated (and incorrect) credit advice tends to linger. It’s no wonder some of us are lost and don’t know where to start when it comes to managing credit. In a recent study, we even learned that one in four Americans can’t tell the difference between a credit score and credit report.
To demystify fact from fiction, we brought together the most important credit facts you need to know to understand your credit and everything that impacts it. Take a look at our list below to learn more.
1. Your credit score is based on five core factors.
Five factors impact your FICO score and each criterion accounts for varying percentages of your credit score. These factors are important to keep in mind when applying and using credit. Some credit myths, like carrying a balance to improve your score, can actually damage your score and increase unnecessary debt if you don’t know the real credit facts. Take a look below at the five factors that impact your score.
- 35% – Payment History. Your ability to consistently make payments makes the biggest impact on your score. Late and missed payments are the most detrimental to your credit score. Catching up and staying on time with payments can improve your score.
- 30% – Credit Utilization. This is the next most impactful aspect of your credit score. Credit utilization is determined by the amount of credit you’re using compared to the total credit you have available. The lower your credit utilization, the better your score.
- 15% – Length of Credit History. Credit history takes a smaller, but still important role in influencing your credit score. A longer credit history gives the credit bureaus a bigger snapshot of your past transactions. This allows them to predict how you will handle your credit and your potential risk.
- 10% – Inquiries and New Credit. The number of formal requests (known as inquiries) to review your credit report affects your score as well. Too many hard inquiries can negatively affect your score, but inquiries made during a short amount of time are generally less harmful since the credit bureaus understand these likely occur on a case-by-case basis, like when you’re shopping for a car.
- 10% – Diversification of Credit. Lastly, the diversity of your credit types makes up the last area that impacts your credit score. A diverse credit portfolio benefits your credit score since it demonstrates your ability to successfully manage different types of credit.
2. Credit reports are different from credit scores.
Credit reports are different from credit scores. Credit reports list every piece of your financial history that affects your creditworthiness. Reports are helpful if you want to review your credit history to find any inaccuracies, instances of fraud or just want to know how you’re financially performing.
Your credit score, on the other hand, is a numerical grade of your creditworthiness. Checking on your credit score gives you a quick snapshot of your score if you want to know where you stand before you start house hunting, car shopping or anything else that relates to your credit.
3. Negative credit items will eventually come off your credit report.
Most negative items will remain on your report for seven years at the most due to the regulations set by the Fair Credit Reporting Act. Bankruptcy, on the other hand, can last up to 10 years or more in some cases.
4. FICO credit scores range from 300 to 850.
Credit score ranges vary depending on the credit bureau. Knowing your score can help you understand how you can improve it. For example, if you’re looking to move from “fair” to “good,” it’s important to know where those scores lie on the spectrum. Below you can find the credit ranges used by FICO.
- 800–850: Exceptional
- 740–799: Very Good
- 670–739: Good
- 580–669: Fair
- 300–579: Poor
5. Majority of lenders use FICO scores when making decisions.
Bill Fair and Earl Isaac founded the FICO credit scoring system in 1956 as a way to help lenders make well-informed lending decisions. FICO analyzes scores from the three major bureaus: TransUnion, Equifax and Experian (sometimes referred to as “The Big Three”).
90% of lenders use your FICO score when making lending decisions. More recently, the The Big Three came together to create FICO competitor VantageScore to offer a more consistent score across the three bureaus.
6. You have many different credit scores.
Credit scores vary based on the credit bureau reporting them. The major credit bureaus all have slightly different information regarding your credit history. This means that these three, along with other credit reporting agencies, report several FICO credit scores to lenders to account for different information they’ve collected.
There are also different scores specific to particular industries. For example, auto lenders review different risk factors than mortgage lenders, so the scores each lender receives differ. Although it can get confusing, the most important things to abide by are the five core factors that affect your credit score.
7. Checking your own score won’t hurt your score.
Many believe that checking your credit score hurts your credit, but this is not true. Ordering your credit report or checking your score (called “soft” inquiries) do not affect your credit score. Hard inquiries, like when lenders look at your credit, do negatively impact your score. However, the consequences are small and temporary, especially if the queries are made close together within a short amount of time.
8. You can check your credit score and credit reports for free.
There are three main ways to check your credit score for free. You can ask your credit card company, request your credit score through your bank, or sign up for a free online service. You can also order your credit report for free. In fact, you’re entitled to one free credit report from Experian, TransUnion and Equifax per year. Request your free reports from Annual Credit Report.
9. Your credit score can cost you money.
Low credit scores signal to lenders that you’re a high risk. Due to this, you’ll likely have a difficult time finding a lender and probably end up paying high interest rates. This can stack up over time if you take out a mortgage while your credit score is low.
Here are examples of other things that are affected by a low credit score:
10. Canceling old credit cards can lower your score.
The length of your credit history makes up 10 percent of your credit history. Keeping old credit cards open will positively impact your score since they increase your overall credit age. Having open credit cards also impacts your utilization. All open cards contribute to and raise your overall credit limit. The higher your limit, the easier it is to keep your credit utilization ratio down.
This is crucial since credit utilization is the second most important factor that impacts your credit score. Closing a really old credit card or a card with a high limit can drastically drop your score. If you need to cancel a card, consider raising the limit on another card to keep your utilization ratio similar.
11. You can still get a loan with bad credit.
Bad credit loans are available for those with low or non-existent credit scores. Depending on the type of loan, you might need to pay high interest rates and offer a valuable asset that a lender can seize if you’re unable to pay back the loan.
12. Credit scores aren’t the only deciding factors for lending decisions.
Like we mentioned earlier, other aspects impact a lender’s decision to grant you a loan or a credit card. Some lenders allow you to give a personal appeal to give context to your credit report. Other factors like a steady job and enough income can also demonstrate your ability to pay back a loan. This brings us to our next credit fact.
13. Your credit report can help you spot fraud.
Periodically checking your credit report allows you to spot fraudulent activity. Any large changes in your score are signals to check your report for any inaccurate information. Once you see any unrecognized inquiries on your report, you should double-check that the purchases and inquiries listed match up to your recent activity. There is a series of steps you should take once you realize you’re a victim of fraud, like authorizing a credit freeze and adding a fraud alert to your credit report.
14. Joint accounts affect your credit scores, but you do not have joint scores.
The activity in a joint account is reflected in both credit reports. For example, if you and your spouse apply for a mortgage, the lender will consider both of your credit histories when making a decision. This does not mean that you and your spouse have a joint or combined credit score.
Note that a joint account is different than an account with an authorized user. Joint account holders can use the account and are liable for the debt, while authorized users can use the account but are not liable for the debt.
15. Many credit reports contain inaccurate credit information.
The Federal Trade Commission found in a study that one in five people has an error on at least one of their credit reports. This is why you should frequently check your credit report and dispute any inaccurate information you find. These inaccuracies can greatly impact your score depending on the error. For example, one wrongfully reported late payment can drastically drop your score since payment history impacts 30 percent of your credit score.
It’s important to get your credit facts straight so you understand exactly how different things impact your score. One of the first things you should learn is how to read your credit report so you can quickly spot discrepancies and ensure that the information reported is fair and accurate. After scrutinizing your credit report, you can look into other ways to fix your credit, like paying late or past due accounts, so you can boost your score with your newfound knowledge. You can also take advantage of Lexington Law’s credit lawyer-driven process to get extra help and additional legal knowledge to assist in your credit repair process.