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Garnell Shumate wants to buy a home in 2011, so she works hard to maintain a good credit score. Each year, the Hackensack, New Jersey, resident requests a copy of her credit report from each of the three major credit reporting agencies and makes sure to dispute any items that are incorrect. “The goal has been to pay down the cards with highest interest and work my way down,” says the 41-year-old owner of an online dog clothing consignment shop. Shumate understands that the ability to purchase a home is largely dependent on her ability to manage debt.
If you, like Shumate, plan to make a big purchase in the near future, it’s important to understand all the factors that affect your credit score. You also need to be able to separate fact from fiction. Below are a few common myths about credit and debt management.
Myth: If you have a good credit score, you don’t have to pay attention to what’s in your credit report.
Reality: Read and understand what’s in your credit report. A mistake could cost you the best rate on a loan or cause you to be denied. It could also make you a target for identity theft. Look at the accounts carefully and make sure they’re yours,” says Liz Weston, personal finance columnist for MSN Money and author of Your Credit Score, Your Money & What’s at Stake: How to Improve the 3-Digit Number That Shapes Your Financial Future (FT Press; $18.99). If you see an account that is not yours, dispute it. “Ask for validation to prove the debt is yours. If they can’t prove it, they have to remove it. If you’re ignored, see a lawyer with knowledge of credit card laws,” says Weston.
Myth: Credit inquiries will ruin your score.
Reality: “Credit inquiries don’t matter as much as rumored,” says Weston. “Your score is impacted by about five points, but then it fades quickly in a few months.” A “hard inquiry,” which remains on your credit report for two years, occurs when you apply for credit or a car loan or open a bank account. A hard inquiry will lower your score, but only for the first year that it’s on your report. A “soft inquiry” occurs when you yourself, a prospective employer, or a lender with whom you have an existing relationship checks your credit report.
Myth: Bankruptcy will solve all your credit problems.
Reality: “Bankruptcy is the single worst thing you can do to your credit, so call [creditors] about a solution first,” says Weston. Chapter 7 bankruptcy remains on your report for 10 years and Chapter 13 for seven years. Your credit score can drop by as much as 300 points.
Myth: You’re safe as long as you pay the minimum.
Reality: Credit utilization is important. FICO credit scores look at balances reported and available credit. The higher one’s percentage of credit used, the more damage it does to his or her score. “Paying the minimum may put you in good stead with the credit card company, but there’s still an unpaid balance over time, which affects your score,” says Barry Paperno, consumer operations manager for myFICO.com. Experts advise using as low a percentage of your available credit as possible, but the ideal percentage is below 10%.