| Many people wonder: "Why does that three-digit credit score have such an impact on my financial life?"
To be clear, that credit score, a rating of your credit worthiness, will affect the interest rate that you pay on a mortgage, auto loan, for insurance, your cell phone plan and even your ability to land certain types of jobs. And that can have a huge impact on your budget over time. To that point, the lifetime cost of higher interest rates from bad or mediocre credit can exceed six figures.
A credit score is the number that lenders use to help decide whether you get a mortgage, a credit card or some other line of credit, and, of course, the interest rate you are charged for this credit — which can make debt more or less expensive for you. The score is a snapshot of whether you're a good credit risk to the lender at the time of your application. So, yes, your credit score plays a huge role in your financial life.
I reached out to some experts and asked this key question: What actually has the biggest impact on a credit score? The answer was payment history. It's the most important factor in maintaining a higher credit score. It accounts for 35% of your FICO score, which is the score used by about 90% of the top lenders. FICO considers your payment history as the leading predictor of whether you'll pay future debt on time. So that means paying your bills on time will have the biggest positive impact on your credit scores. That seems logical.
Despite the importance of credit scores, they remain widely misunderstood, so it's important to understand them.
I asked those experts about some common credit score myths that need some debunking. Here's what they said:
- Does checking my credit score affect my score? No, checking your credit score will not have an impact on your credit score. That's because this type of credit check is considered a "soft inquiry," which differs from the "hard inquiry" that occurs when a lender pulls your credit report.
- Will carrying larger balances help my credit score? It's true that you do need to use credit in order to generate a high score. However, the idea that you have to carry large balances every month to boost your score is false.
- Will my credit score increase when my income increases? No. It might be surprising to learn that income plays no role whatsoever in the calculation of a credit score.
- Will using my debit card help me build my credit score? Responsible debit card usage can be a sign of financial maturity, as you'll have to manage your account to ensure you have enough money to pay for all of your monthly expenses. Unfortunately, a sound financial habit like using your debit card won't matter one bit to your credit score.
- Should I close unused credit cards to boost my score? It may seem to make sense that closing your unused credit cards would boost your credit score. Unfortunately, the exact opposite is actually true. For starters, the closure of a card lowers the amount of your available credit, which can knock your score down by a few points.
For more advice to help you make smart financial decisions, check out CNBC's Financial Advisor Hub and Personal Finance section. |
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