Don’t believe anyone who tells you that credit scores are irrelevant to your financial health.
But you also shouldn’t believe that credit scores are any reliable indication of your financial health.
You can be a multimillionaire with no credit score, or someone with excellent scores who's on the brink of a financial meltdown.
Indeed, economists currently are worried about a steep rise in foreclosures among "prime" customers, those who had good credit when they got their mortgages but who took on too much debt or lost their jobs in the recession.
The confusion over what credit scores are, and what they do, leads to some unfortunate attitudes:
- Some people dismiss credit scores entirely, either believing scores have no effect on their finances or out of a general disdain for credit and debt.
- Others understand that scores are important but believe that if they handle their money well, their scores automatically will be good.
- Still others are positively obsessed with their scores, focused on boosting them as fast as possible without considering how their actions might affect the rest of their financial lives.
All of these folks are misguided and could be risking some serious fiscal fallout. Let's take these myths one at a time.
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Myth No. 1: Credit scores don't matter
Here's the truth: Credit scores are increasingly critical to the financial lives of most people.In today's credit crunch, only people with good scores are snagging the best rates and terms on mortgages, credit cards and other loans. They can effectively fight back against the credit card rate increases and limit cuts so prevalent today. (See "Thaw out your frozen credit" and "5 tips: Protect your credit scores now" for more.) Meanwhile, many people with bad scores are paying far more for credit or being turned away entirely.
Even if you've paid off your home and never plan to borrow another cent, you may still need to be concerned about your numbers. Credit scores are used by insurance companies to determine premiums and by landlords to evaluate applicants. (Employers often review credit information as well, although they tend to look at your entire credit report, rather than just a three-digit credit score.)
Furthermore, you can have great scores without being in debt.
While having installment accounts such as mortgages and auto loans can boost a score, they're not essential.
You can achieve a score of 750 or above over time just from credit card accounts that you pay off in full every month, according to FICO, the company formerly known as Fair Isaac that created the leading credit scoring formula. In other words, you don't have to pay a dime of interest to get and keep good FICO scores.
Video on MSN Money
How to fix your FICO scoresMSN Money experts Liz Pulliam Weston and Jim Jubak explain how lenders use FICO scores and how you can improve your own.
Myth No. 2: Great finances make great credit scores
I wish.Credit scores were designed to help lenders gauge a borrower's risk of default. That's it. The only information used is what's in your credit report. The formula is particularly affected by:
- Whether you pay your bills on time.
- How much of your available credit you're using.
- How long you've had credit.
- How recently you've opened a new account.
- The mix of credit you use.
Here's what does not go into a score:
- Your income or how much of it goes to pay debt.
- Your net worth.
- Your retirement account balances.
- Your investment returns.
- Your employment history or prospects.
- Whether you live within your means.
- Whether you pay your credit card bills in full each month or carry a balance.
Continued: Great credit scores make great finances?
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bankruptcies. Where are their brains?