If you’re in the market for a home loan, and you want to get the best rate, you may be looking to improve your credit score. So you start by doing what you think are all the right things: paying off some collection accounts, closing some credit lines. But you may be surprised to learn that actions like that can actually hurt your credit score, at least in the short term. That’s because what makes common sense doesn’t always make credit sense. In this article, we debunk the top three myths about increasing your credit score and get you on the road to improving your borrowing power quickly.
If there’s anyone who knows credit improvement, it’s Todd Archambault, President of eCredit Advisor. Archambault’s been in the business for close to 20 years now. We asked him what misconceptions he sees most with his clients. And in this blog, we’re going to debunk the top three myths about improving your credit score.
Myth #1: Paying off collection accounts helps my credit score
Won’t you look better to creditors if all your debts are paid off? It sure feels like it. But not so fast, according to Archambault. That’s partially because everything on your credit profile is governed by the date of your last activity. If you pay the collections account in full, it shows up as recent activity on your credit report, re-aging the debt and bringing that negative account now current. And that negatively affects your score.
Plus, while this could help in the long term (especially if you’re trying to improve your financial position), the negative impact on your credit does not go away immediately. In fact, that activity probably won’t come off your credit report until it reaches the statute of limitations (usually around 7 years). But, if you leave it alone, it shows up as old information on your report and has less impact on your credit score. If you’re looking to increase your credit score quickly (on the path to a loan, for example), you may want to wait to pay off that debt.
Myth #2: Closing credit cards accounts helps my credit score and having too many open credit cards could hurt my credit score
It sounds strange, but it’s important to have at least three lines of credit open, active, and in good standing so that monthly, they’re reporting your lending activity positively to the credit bureaus. Let’s take a step back and look at why: everything on your credit report is governed by percent of utilization. That means that the credit bureaus look at how much credit you’re currently using (how much you owe, essentially) divided by the total amount of credit available to you (your credit limit). The rule of thumb is to keep this at about 30%. That ratio shows creditors that you know how to manage your spending. If your rate is higher, it sends the opposite message. And Archambault says, “Banks lend money to people who don’t need it.” If you close all of your lines of credit, you lose your ability to show payment history, and those positive payments every month work in your favor! The more active open accounts you have, the easier it is to build your credit score. Having a small $5 or $10 balance on a credit card is going to give you a higher score. So keep that credit card and just use it once every 12 months.
Myth #3: Buying a car will help my credit score
This one’s a doozy, and it may change the way you approach car buying in the future. Archambault says if you take a good credit score into a car dealership (620 or above) with the intent to finance a new car, what the dealership does, essentially is “shotgun your credit.” They stand to make a return by placing you with a financial institution. So they farm out your credit score and shop you around to different financial institutions. Sounds harmless until you understand that this means they’re doing a hard inquiry on your credit about nine different times. That’s a LOT of hard inquiries, and that will definitely affect your score, sometimes, Archambault says, dropping it down 40 points!
Archambault says it’s better for you to go directly to your financial institution before even setting foot inside the dealership. They’ll pull your credit once. Then, have them finance the entire balance. For example, if you were planning to put $5000 down on a $25,000 car, Archambault says, finance the entire $25k with your financial institution. Then immediately pay the $5000 so you’re not only showing good payment history, but you’ve improved your balance to limit ratio right out of the gate!
On the path to good credit, a lot of us turn to the internet. Keep in mind there are a lot of online outlets that claim to give you an accurate reading of your credit score. Archambault says many of these sites show scores that are usually 60 points higher than what lenders in the mortgage industry pull. Lenders use your FICO score to qualify you for a home loan, and the only way to get a truly accurate FICO score is to have a mortgage advisor pull it for you. If you’re interested in learning more, reach out to us today at 702-255-5783.
There are plenty more myths out there about how to improve your credit, but if your goal is homeownership, then getting on the path to a good credit score is a must. Not only will it help you qualify for more financing, but the less you’ll likely pay in interest on your loan. Archambault says his credit improvement program is not about perfect credit, rather it’s designed to get your credit score as high as possible with the least amount of money out of your pocket in the fastest amount of time. But, there’s a catch. You have to do your part to improve your score. If you don’t, eCredit Advisor puts your service on hold until you’re ready. Give them a call if you’re ready to make some changes today!