FICO scores have been around since 1989, but they weren’t thrust into the public’s eye until the mid 1990’s when Fannie Mae and Freddie Mac endorsed their use in the mortgage environment. And by “endorsed” I mean, “forced.”
Mortgage lenders had until the late 90’s to fully implement FICO scoring into their underwriting processes. I was at FICO (FICO) when this happened and one of my jobs was to criss cross the country speaking at mortgage broker and banker events teaching these really angry people about the new tool that just got shoved down their throats. Talk about being the least popular guy in the room.
This GSE “endorsement” also meant a whole lot of public scrutiny of a tool that had always remained a secret to consumers, albeit unintentionally. I mean, if you don’t sell something directly to consumers then why would consumers know about it? No, FICO’s entry into the mortgage market meant more press, more attention, more criticism, more work for me, and a whole lot of incorrect information being passed off as the truth.
So, here is a list of a few FICO score myths that I have run into over the past 12 years. And, the subsequent debunking. There are certainly many more, which I will address as time goes on.
FICO Scores Consider Income, Yes or No?
The answer is NO. The FICO scores that we’re all familiar with are credit bureau-based scoring models. That means they only consider information on your credit reports. And, guess what, your income is not on your credit reports. There are models that consider income, as listed on your credit applications, but these are not the FICO scores that we all know and love.
John’s Final Thought: Income is a measurement of capacity (whether or not you can afford your payment) not creditworthiness (whether or not you’ll choose to make your payment.)
Closing a Credit Card Will Improve Your FICO Scores, Yes or No?
The answer is NO. This makes common sense, less available credit means you can’t get into as much credit card debt and therefore you’re a better credit risk.
The problem with that hypothesis is that it’s incorrect. And, thankfully, credit score development isn’t a common sense exercise. The empirical evidence shows, and has shown for over two decades, that having a lot of “open to buy” (unused credit limits) equates to better credit risk. This is commonly referred to as “revolving utilization”, the percentage of your credit limits that you’re currently using. Closing cards can actually increase this utilization percentage and lower your scores.
There’s a secondary myth to this one that says keeping your utilization percentage at or below 30% is the best for your score. That’s also incorrect. Nothing magical happens at 30%. It’s better than 40% but not as good as 20%. In fact, according to FICO, consumers who have scores above 760 have an average utilization percentage of just 7%.
John’s Final Thought: Shoot for lowering your balances to $0 if you can but if you can’t, get them as low as you can and your FICO scores will benefit. NOTE: This only applies to credit cards, not installment loans.
Closing a Card Causes You to Lose the “Age” Benefit of That Account.
This is incorrect. One of the secondary factors in your FICO score is the average age of the accounts on your credit reports. The older the average, the better for your scores. There’s a myth that closing a credit card account will somehow remove that card from consideration in the average age calculation.
Here’s the real deal: FICO scoring considers open and closed cards when determining the average age of your accounts. Closing the card doesn’t remove it from your credit reports so it’s still going to be considered.
John’s Final Thought: Be careful when deciding to close credit card accounts. Re-read myth #2 above for the reason.
Spreading Balances Across Multiple Cards Helps Your Scores.
Incorrect. First off, there’s no hiding credit card debt by doing this. $10,000 on one card is still the same amount as $1,000 on 10 cards. The aggregate revolving utilization percentage (see #2 myth above) is that same either way so you gain nothing there. But, what you have just done is to increase the number of accounts you have with a balance greater than $0, which is going to lower your scores.
John’s Final Thought: Stop trying to beat the system. Do you think the folks at FICO are idiots? Pay off your credit card debt, stop trying to shuffle it around.
Keep your eyes open for episode #2 of FICO Mythbusters. Coming soon to a Mint near you.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and the author of the “credit history” definition on Wikipedia. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. He has served as a credit expert witness in more than 70 cases and has been qualified to testify in both Federal and State court on the topic of consumer credit.