Dubai: While you’re probably already aware of how a good credit score helps you get the best interest rates on a loan, and that’s just the beginning of how the three-digit number impacts your financial life.
Your credit score, a rating of your credit worthiness, can also affect the rate that you pay for car and homeowner’s insurance, get you access to better credit cards and other banking products, alongside helping you qualify for higher borrowing limits.
A credit score is based on your credit history, which includes information like the number accounts, total levels of debt, repayment history, and other factors. A credit score is primarily based on a credit report, information typically sourced from credit bureaus.
However, despite its importance, myths and misunderstandings still persist when it comes to matters concerning your debt and related credit reports. Here’s a look at five common misconceptions surrounding your credit scores.
Myth #1: All debts equally affect your credit score
Let’s say you've got a Dh150,000 debt on your credit report. If it's there because you maxed out your credit cards, then you're in trouble. But if that Dh150,000 is your mortgage or locked in the form of a home loan, then you're far safer.
“While all debt balances on play a role in your credit score, your revolving credit card balances factor more heavily into your credit scores. That's because they impact your credit utilisation ratio, which is a major scoring factor in credit scoring models,” said Dubai-based credit advisor Rupesh Naish.
“Beyond how much debt you have, your history of paying it back is what carries the most weight in your credit score, because it reveals whether you have a history of repaying funds that are loaned to you. So prioritise paying back your debts over worrying how your different debts are affecting you.”
Myth #2: There is only a single credit score
There isn't just one single credit scoring formula that applies to all consumers in all situations. There are a lot of scoring models in use when credit checks are done, which means a consumer can have more than a few credit scores.
“Lenders and others check your credit score for different reasons, and each formula looks at your credit history in a different way, giving different weight to various factors,” explained Rajesh Markara, an Abu Dhabi-based debt restructuring advisor.
“Although your credit scores are calculated using information in your credit reports, there are also many different credit scoring models, or ways of calculating credit scores. However, a credit bureau would issue only one credit score.”
Myth #3: Credit scores can be ‘good’ or ‘bad’
While a score of 720 or higher is generally considered ‘excellent’ credit, a score of 690 to 719 is considered ‘good’ and scores of 630 to 689 are viewed as ‘fair’. Any scores of 629 or below are ‘bad’ credit. However, bear in mind that neither of these scores are objectively ‘good’ nor ‘bad’.
“Credit scores are simply a measure of risk, and it's up to lenders to decide whether a given score meets their criteria for extending credit,” added Naish. “And, scores are usually just one factor in their decision.
“A ‘good’ score might not mean much if you don't have a job or any assets. Likewise, a high income might outweigh a ‘bad’ score. So higher credit scores simply mean you have demonstrated responsible credit behaviour in the past, deeming you are either acceptable or lower-risk borrower.”
Credit scores are simply a measure of risk, and it's up to lenders to decide whether a given score meets their criteria for extending credit
Myth #4: Paying off your debts erases your score
The evidence of your debt can stick to your credit report for years even after you’ve paid off a debt. “If you pay your debts on time and in full, you will want your paid-off accounts on your report because they show that you've used credit responsibly,” added Markara.
“If you've been chronically late, missed payments or defaulted entirely, that's a problem. Most negative information can remain on your report for up to seven years; some bankruptcies can stay there for up to 10 years.”
If you've had credit in the past but no longer use credit cards, or you have closed accounts on your report, there won't be recent activity to produce a score for you, said Markara, while adding even if you have recent credit activity, you may not have scores if your lenders don't report to the bureaus.
Myth #5: Carrying a debt will improve your score
Nearly 60 per cent of consumers believe that carrying forward debt every month helps keep your credit scores from dropping, according to several surveys. However, this is also a fact that is widely misunderstood.
One of the main factors in determining your credit score is your ‘credit utilisation ratio’, i.e. the percentage of your available credit that you’re using at any given time. The lower the number, the better – but aim to keep it under 30 per cent.
“You don’t want to carry a balance, because that’s just pushing up your utilisation ratio,” said Naish. “For most credit scoring models, a high utilisation ratio can impact your credit score as long as your balances remain high. If you pay down your balance, you could see a positive effect on your scores.”