When it comes to credit, most Americans know a few key points. They understand that a good credit score is important and a bad score can stop them from getting a credit card or qualifying for a loan. After that, there’s a good deal of confusion and misinformation, according to a new survey by the financial website NerdWallet.
“I’m really heartened that people know credit scores exist, and that they have a general idea about how they work, but some important details are still escaping a lot of people,” said Liz Weston, NerdWallet columnist and author of the book “Your Credit Score.”
“People still don’t understand how pervasive credit scoring is in their financial lives," she told NBC News. "They’re missing how important good credit is to all areas of your financial life, not just for borrowing money.”
The NerdWallet survey of more than 2,000 adults found that:
- Eleven percent thought everyone starts with a perfect credit score. In fact, credit is something you build over time by using credit responsibly. But you can trash that score overnight if you pay bills late or max out your credit cards.
- About half (49 percent) didn’t know that having bad credit can limit a person’s options for cell phone service. There are ways to get a cell phone without a credit check, such as with a prepaid plan, but people with poor credit have fewer options.
- More than two in five (41 percent) mistakenly believed that carrying a small balance on a credit card month to month could help improve a person’s credit scores.
“The reality is you do not have to carry a balance; you don’t have to have debt to have good credit scores,” Weston explained. “You need to have credit accounts and to use them lightly, but regularly. There is no reason to carry a balance. There’s no reason to pay a penny of interest. I don’t and I have terrific scores.”
Capital One’s Credit Confidence Study released at the end of last year found similar widespread misconceptions regarding a range of issues dealing with credit and what factors will help or hurt your scores.
Two-thirds (66 percent) of the 2,300 adults surveyed believe people with good credit get special treatment and more than half (55 percent) agree that people with bad credit are treated like second-class citizens. But many did not understand the full implications of having poor credit.
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For example: 31 percent said closing an unused credit card account is a good thing. In fact, it could be harmful. That’s because the average age of your accounts is a significant factor used in generating your credit scores. Keeping your oldest cards open typically helps your scores. It would make sense to close an unused account if you are paying a high annual fee and not about to apply for credit in the near future.
“Obviously, there are the financial implications of not being able to get an auto or home loan, or getting a higher interest rate if you do get approved,” said Pranav Khanna, vice president of product management at Capital One. “But there’s a lot of stuff people don’t know about – and even what they think they know is sometimes inaccurate.”
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Some Common Credit Myths
Most of us refer to our “score,” as if there’s just one number that reflects our creditworthiness. In fact, most of us have many credit scores depending on the type of lender involved, which of the big three credit bureaus they contact and the scoring program that’s used. “You have many credit scores and they change all the time, so the score you get for free from your bank or a website might not be the same score a lender is using – and that causes a lot of confusion,” Weston said. “People think there should be one score that everyone sees, but that’s not the way it works.”
In fact, mortgage lenders use a unique scoring model that’s even different from the free FICO score you can get. That’s why Weston recommends going to MyFICO.com and paying for your score. If you want to see what the lender is seeing, that’s where you have to go to get it, she said.
There’s also a good deal of confusion about what’s a good score. The most common credit scores rate our creditworthiness on a scale from 300 to 850.
One in five people surveyed by NerdWallet thought a score above 600 is good. In fact, anything below about 620 is considered subprime. That means it’s going to be hard to get credit and you’re going to pay more for it – typically in the form of higher interest rates – when you get it. The goal is to be over 720 (considered good) and try to top 760 (excellent).
“Once you get above 760, you’ll find that you get the best rates and terms, you get the best treatment because lenders really want your business, landlords trust you and insurance companies want your business,” Weston told NBC News.
The Widespread Use of Credit Scores
Credit scores are used for much more than granting credit and determining interest rates. A few examples: Employers often do credit checks before hiring someone. Many utilities determine the deposit required based on a customer’s credit score. Rental applications typically require credit checks. And insurance companies often look at their customers’ credit scores.
Recent studies by insurancequotes.com found that poor credit can drive up the cost of auto insurance (except in California, Massachusetts and Hawaii where the practice is not allowed) and homeowners insurance in most states.
“Even drivers and homeowners with fair credit pay much more than those with excellent scores,” said Laura Adams, senior insurance analyst at insuranceQuotes. The studies found that:
- With auto insurance, someone with fair credit will pay an average of 28 percent more for car insurance than a driver with excellent credit. A driver with poor credit could see their premium double.
- Policyholders with fair credit pay an average of 36 percent more for homeowners insurance than those with excellent credit. Someone with poor rather than excellent credit will see their premium more than double, increasing an average of 114 percent.
“It's never too late to improve your credit so you pay less for credit accounts and cut the cost of auto and home insurance,” Adams told NBC News.
What You Need to Know
Credit scores are based on five basic factors: payment history, credit utilization, length of credit history, types of credit and new credit.
One of the best things you can do is to pay your bills on time, all the time. If you can’t pay off the balance in full, then at least make the minimum payment. Just one late payment of 30 days or more can cause your scores to tank.
And don’t use too much of your credit. You want that credit utilization — the percentage of the available credit you’re using at any one time — to be less than 30 percent for each account and all of them combined. Financial experts say 20 percent utilization or less is even better.
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Remember: Maxing out your credit cards or even getting close to the limit will hurt your scores, even if you make your payments on time every month and don’t go over your limit. As your debt burden gets higher, you’re seen as a bigger risk to creditors.
Many people believe checking their credit score will lower them. It won’t. So if your bank or credit card company offers such a monitoring service, it’s a good idea to use it — to keep track of how you’re doing. Various websites also offer free scores, but you may get ads from that company.
The Consumer Financial Protection Bureau has information about credit reports and credit scores on its website.
Herb Weisbaum is The ConsumerMan. Follow him on Facebook and Twitter or visit The ConsumerMan website.