Good news! FICO®, the company whose technology is behind the credit scores used by more than 90 percent of top lenders, says that the average score for Americans is now at an all-time high. In April 2015, that average was 695, and there were more people in the 800+ group and fewer in the sub-550 one. When it reported the news, The New York Times thought some of the improvement might be down to consumers better understanding how scores work, and that could be partly a result of more using completely free credit score monitoring services – such as the one offered by LendingTree. These typically provide customized tips and information each month as well as an updated score.
But if information on credit scores is more widely available than ever, misinformation continues to be commonplace and myths abound. Back in June 2015, one renowned publisher of news and information ran an article on credit scores that, if it wasn't largely flat-out wrong, certainly gave readers some very misleading impressions. When members of the LendingTree team read it, they were outraged. But then they thought again: How could they be sure their knowledge, albeit built up over many years, was correct, and the famous news outlet's information wrong or misleading? So they decided to check with an expert, and asked Can Arkali, who's Principal Scientist in Analytics and Scores Development for FICO, to help.
Myth: Shopping Around for Loans Harms Your Score
The iffy article bemoaned the "fact" that shopping around for a loan can have a serious impact on your credit score. It cited the example of someone who went into a car dealership, and saw three auto loan applications processed in one afternoon, believing each was knocking some points off his score. But that simply wasn't the case. For many types of borrowing, if you're rate shopping for one loan within a focused period, all those applications count as just one. FICO's Can Arkali explains:
When evaluating inquiries, the FICO Score leverages "shopping windows" to allow consumers time to search for new credit. Looking for a mortgage, auto or student loan may cause multiple lenders to request a credit report, even though the consumer is looking for only one loan. To compensate for this, FICO Scores ignore mortgage, auto and student loan inquiries made in the 30 days prior to scoring. So, if the consumer finds a loan within 30 days, the inquiries won't affect the FICO Score while the consumer is rate-shopping. In addition, FICO Scores look on the credit report for mortgage, auto and student loan inquiries older than 30 days. If the FICO Score finds some, it will consider inquiries that fall in a typical shopping period as just one inquiry. For FICO Scores calculated from older versions of the scoring formula, this shopping period is any 14-day span. For FICO Scores calculated from the newest versions of the scoring formula, this shopping period is any 45-day span.
Myth: Borrowing a Lot in a Short Time Won't Hurt Your Score
The article gave the example of a couple with excellent credit who financed their start-up venture using their credit cards, running up $100,000 in card debt in the process. Their credit scores dipped for a while, but the business was a big success and three years later their scores had recovered.
Clearly, this story is possible (no doubt it's true), but it's highly exceptional. To start with, very few start-ups have the cash flow to accommodate high interest rates on big credit card balances. That couple could easily have been facing interest payments alone of $15,000 a year.
And, assuming they didn't want their scores to fall quickly, they'd have needed combined credit limits of $333,000 to use $100,000 of credit. That's because using more than 30 percent of your available card credit actively and significantly harms your score. In fact, this "credit utilization" ratio is the second biggest factor in calculating your score, right behind your payment history. Moreover, each new account opened (and you might need quite a few to get limits totaling $0.33 million) reduces your score in two ways: through the initial hit all new accounts bring, and by reducing the average age of all your accounts.
Using business credit cards for purchases can be convenient and provide valuable rewards. But, if your idea is good, there may be cheaper ways to borrow. Learn more at 5 Ways to Improve Business Credit and Get a Better Business Loan.
Myth: Joining a Debt Management Program Necessarily Hurts Your Score
If you run up $100,000 in card debt to start a venture, there's a good chance you might end up thinking about entering a debt management program. The dubious article quotes a so-called expert, who warns, "One of the knocks against debt-management plans is that enrollment is likely to ding a consumer's credit score."
Can Arkali disagrees: "No, joining a debt management program in and of itself will not have an impact on the FICO Score."
That's not to say that these programs are always a good idea, and, depending on how they're implemented, they certainly have the potential to seriously damage your credit score. But enrollment shouldn't do any harm. For more information, and for advice about alternatives, check out the Federal Trade Commission's website.
Having a good or great credit score in 21st century America can make life a whole lot easier and borrowing much less expensive. So it's worth learning as much as you can about how to improve yours. Just make sure you read reliable articles!