The Truth about Credit Scores
A credit score is an important piece of financial information. It’s generated from your credit report, which lists any loan you’ve taken out in the last six years. A credit report also lists how much you owe, how often you pay your debts on time, the limit on each credit account and more. This information is used to calculate your credit score. The exact formula that the credit bureaus use for this calculation is kept secret, but that doesn’t mean that a lot of information about credit scores isn’t known.
However, it also means that there are a lot of credit score myths out there. These myths can make it difficult for the average Canadian to get relevant information on credit scores and credit reports. These rumours can also make it tough for people to know what they can do to improve their credit.
Here are some common credit score myths and the truth behind these myths.
Myth: Checking your Credit Score Hurts It
Fact: This is a common myth that comes from a misunderstanding. There are two types of credit inquiries. One is a “soft” inquiry and the other is called a “hard” inquiry. A soft inquiry has no impact on your credit score. An example of a soft inquiry is a business checking your score for an update, such as a credit card company checking your score before offering you a credit limit increase on an existing account. A hard inquiry is a lender looking into your report before offering you new credit. Checking your own credit report is considered a soft inquiry, so it does not damage your credit score.
It’s important to note that, in many cases, “shopping around” for a good loan (such as looking at different lenders when you’re buying a car) can generate several hard inquiries. However, most credit bureaus understand this situation and group similar requests together if they are made in a small period of time. This is done in order to lessen the impact this has on your credit score.
Myth: A High Income Means a Good Credit Score
Fact: Your income has nothing to do with your credit score. Income information is not listed anywhere on your credit report and does not come into the calculation of a credit score. This makes sense if you think about it. You can make a lot of money and still have a high amount of debt. A big income does not mean that you always make your payments on time and that you don’t miss any payments. It’s also true that someone with a lower income doesn’t necessarily have a lot of debt or not handle debt responsibly. This person could easily have a responsible amount of debt and he or she could have never missed a payment.
Myth: No Debt Means Perfect Credit
Fact: While having no debt is certainly good for your financial health, it doesn’t automatically mean that you’ll have a great credit score. Lenders like to see that you are able to borrow reasonable amounts of money and pay them off as they become due. Having no debt and no credit cards doesn’t show that you can be responsible with debt. While you certainly shouldn’t put yourself in debt just to build your credit score, using a credit card responsibly and paying off the full balance each month shows that you can handle debt, which improves your credit score.
Myth: Paying Off a Debt Completely Removes it from your Credit Report
Fact: While paying off a debt completely is certainly a good idea, doing so doesn’t remove all record of this debt from your credit report. Missed payments and late payments on this account will still show on your credit report for some time. However, the effect of these late and missed payments will decrease as time goes on.
Myth: Bankruptcy and Consumer Proposal Permanently Ruin your Credit Score
Fact: When you file for bankruptcy or consumer proposal, a note is made on your credit report. This note remains for six years after you have been discharged from bankruptcy (if it is your first bankruptcy) and three years after you have completed a consumer proposal. While this note can make it more difficult to get a loan, it doesn’t ruin your credit score forever. In fact, bankruptcy and consumer proposal can put you in a position to rebuild your credit score over time. If you are in financial difficulty and you do nothing about it, you can continue to hurt your credit rating. However, if you file for bankruptcy or consumer proposal, you give yourself the opportunity to repair your credit.