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As American consumers, we’ve all heard a lot about how important our credit scores are to our financial futures. With an endless barrage of advertising and marketing for free credit reports and credit repair services, it’s hard to avoid the megaphone in the street regarding our credit scores. (You can see MLR’s post on how to actually get your free credit report!)

The general public has been very worried about changes from the Credit CARD Act and particularly how it relates to credit scoring. Consumers are more concerned than ever about the importance of their credit scores and how they will affect their financial well-being. The newly enacted legislation was rolled out in an effort to protect consumers from onerous fees and predatory lending practices of banks and credit card issuers.

One of the unintended consequences of the CARD Act, however, is that it has made access to credit far more difficult, even for the most credit worthy individuals. Prior to 2008, anyone with a heart beat could qualify for a credit card … but not anymore.

With an unsteady economy and a stubbornly high unemployment rate, credit worthy consumers have been heavily impacted by the new credit underwriting standards and have come to the realization that good credit scores are more important than ever. The fact of the matter is that there is still a lot of mystery, innuendo and fiction about the basics of credit scores, from what makes up a credit score to how it’s improved.

The Top 5 Myths

But what about the stuff we’ve all heard about credit scores? How can we tell fact from fiction when it comes to credit scores? We’re going to dispel the top 5 credit score myths right here to give you a head start:

1. All You Get Is One Credit Score

Experian, TransUnion, and Equifax are the three major credit reporting agencies and each of them calculates their own version of your credit score with their own proprietary scoring algorithms. Each of the bureaus gathers a different variety of data about your credit and weights the importance of each on a different scale.

While the scoring models each agency uses are different, creditors make their own choice of credit bureaus and typically will default to the lowest score among the 3 bureaus when making their decisions.

MLR’s Note: I’ve always heard they take the middle score. Anyone care to weigh in?

2. Low Income Hurts, High Income Helps

Your income level has no impact on your credit score – it simply just doesn’t matter how much money you make. Having the capacity to repay your debts, no matter what they are, is far more important than having a large income.

What really matters with your credit score is your “debt-to-income” ratio. The lower your debt to income level is the higher capacity that you have to pay your debts. So, a person with $250K in annual income and $200K in unsecured revolving debt has a high debt-to-income level and represents a much greater risk to creditors. An individual with $35K in income and no revolving debt has a much more attractive risk profile for creditors than the high income individual.

3. Close Old Accounts You’re Not Using

Because your credit worthiness depends so much on your debt-to-income, it can be disadvantageous to close old credit accounts, even if you are not using them. Closing an old account can increase your debt-to-income ratio overnight and actually hurt your credit score.

Now, I’m not saying that you should open a slew of new accounts to increase your credit limits either. Opening up a number of new credit card accounts all at once is a huge red flag for creditors and can significantly hurt your credit scoring.

So, keep those old accounts open to maintain that debt-to-income ratio but don’t use the account if you don’t need it.

4. Checking Your Own Credit Can Hurt Your Score

You need to regularly check your credit score at least once a year. To be safe (for example, you are in the market to make a large purchase such as a house), once every 6 months is even better.

One of the most important factors in doing so is that you need to be sure the information being reported to the reporting agencies is accurate. Inaccurate information on your credit reports can be a huge detriment for both your current credit score and also an indication of possible fraud. You can check your credit as often as you want and it will not negatively affect your credit score.

5. Loan Shopping Will Hurt Your Credit

If you’re shopping for a car or looking to refinance your mortgage and you apply for financing with multiple vendors within a short-time frame (roughly 2 weeks), this will not affect your credit adversely. Understanding how common place that rate shopping is for consumers, credit bureaus roll up these inquiries into a single bundle so as not to negatively impact credit scores.

However, if you apply for credit from a number of different sources, such as a car loan, home loan and credit card all at the same time, this type of behavior signals a level of desperation for credit that will hurt your credit score.

Now, Go Improve Your Credit!

With this new knowledge, start out by checking your free credit report and correcting any inaccurate information. It is a headache if there is incorrect information, but 100% necessary.

Once you have corrected your credit report, give it a few months and get another credit report from one of the other agencies (to keep them free!). Make sure it is accurate. Now you are good to go. If a large purchase (car, home, etc) is coming up soon, check your credit score as well so that you know what kind of interest rates you can receive.

MLR’s Note: If you aren’t actively looking at a loan, a site like creditkarma acts as a great thermometer to measure your approximate credit score, the direction it is moving, and why.