YNAB BLOG

Credit Score Myths and MORE Samurai Combat Tactics

Welcome back, Grasshoppa! I, Jeremy, have awaited your return. If you missed it, last time we covered some credit score basics and provided a path to getting a free copy of your credit report.

If you are now or will ever be a mortgage shopper, the following will serve you well. I have seen many a mortgage application die at the hands of the cunning FICO, so let us not delay.

[*POOF!* I disappear from my seated lotus position in a bluish cloud of smoke and reappear beside a living, breathing credit report. “Gah!” you gasp.]

Be not afraid, Grasshoppa! By learning the furious five parts of its anatomy we can uncover corresponding attacks. The percentage shown is the weight each part carries in your total score.

Part 1 – Payment History (35%). Late payments hurt. A lot. For seven years. (!) Lenders will check your credit before approval and sometimes again before closing. If you have missed any payments during that time, FICO could deal a fatal wound to your mortgage application and slay your homeownership dreams on the spot.

  • Myth 1 (thanks to a helpful comment by MrMcLargeHuge): “An unblemished credit report is suspicious. Lenders want to see some kind of mistake in your credit history.”
  • Combat tactic: Noble lenders look for healthy borrowers while predators look for weaknesses. Colorful ad slogans like “Bad credit? No problem!” should warn you like the bright bands of the deadly coral snake.
  • Myth 2: “Never pay off your balance completely.”
  • Combat tactic: Know which credit lines you have open (by seeing your report) and make sure to keep them paid. If you can only pay the minimum, do it. DO pay your balance off each month; however, DO NOT necessarily close the account. We’ll cover that later.

Part 2 – How Much You Owe (30%). If you have a car loan, student loans, and three credit cards maxed out, this indicates a risk that you will be unable to repay your obligations should something unexpected happen (illness, loss of job, an “amazing” shoe sale, etc). Even if you are keeping up on your payments, FICO will ding you for maxing out.

Also, if you have more credit lines available than you could ever hope to repay, it negatively affects your score.

  • Myth 1: “As long as you pay them off every month, you can max out your credit cards.”
  • Combat tactic: Keep your balances at or below 25% (some even say 10%). For example, if you have a $1,000 credit limit, only spend $250 before it’s paid off.
  • Myth 2: “If I have a lot of credit available to me, it shows lenders I can handle the responsibility.”
  • Combat tactic: If you earn $4,000/month, it will make FICO nervous if you can dive into $20,000 of credit card debt at 22% interest rate in a moment’s notice. Limit your credit cards to three.

Which three? Ahhh, you show wisdom for one so good looking, Grasshoppa. Don’t go creating credit card confetti with your katana just yet.  Next time we meet, we will explore the three remaining parts of credit score anatomy and bring the whole creature into view.

*You have, no doubt, heard many myths and developed your own tactics. I cordially invite your questions and comments. When you do, we all get stronger.

17 Responses to “Credit Score Myths and MORE Samurai Combat Tactics”

  1. jcw3rd

    I have 0 (that’s zero) monthly income. I’m retired and living off investments. How is it that I have an 838 credit score with no income? Yes I pay off my 4 credit cards (one is a gas card) in full monthly. What does FICO use instead of income?

    • Ben K

      The FICO score does not include any measurement of income or net worth.

      While you should monitor your credit report for accuracy, your credit score is a terrible indicator of your financial health.

      You could be handed 10 million dollars tomorrow and your FICO score wouldn’t change one point.

      The FICO/credit score is simply a rating based completely on your interaction with debt.

      It’s also good to know that your FICO score will disappear (become “0”) if you don’t regularly interact with debt. If you are debt-free for as little as 6 months, this can happen — but, it’s not necessarily a bad thing… in fact, many believe it to be a good thing. A “0” credit score is an “unknown”, which is actually better than a bad/low score.

      A (very) common misconception is that you can’t get a mortgage without having established your credit. In reality, if you have the right lender, they will do a manual underwriting procedure that looks at things such as income, payment history on utility bills, rent, etc. to establish your risk level. If you stay debt-free and responsibily manage your money, paying your bills on time — you’ll have absolutely no problem getting a mortgage.

    • jeremypeyton

      FICO has no idea what your income is and it is not factored into your score. Conversely, you could be a bajillionaire and have terrible credit. It scores based on your borrowing history. My guess is you haven’t been late in a payment in years (if ever), but you use your credit at least monthly, and don’t max them out. Am I on track?

    • jeremypeyton

      Thanks for pointing out that error on my part. Since FICO does not know your income level, I should have said, “FICO will get nervous if you suddenly go from having $4,000 of credit available to having $20,000 available.”

      • jcw3rd

        Yea, it was that comment about ‘income’ that triggered my initial post in the first place. Thanks for clarifying.

    • curiousgeorgewashington

      Hey jcw3rd,

      Early retirement and living off investments is a goal of mine. Im currently 24 and looking for some good advice as to where I should be putting my money for high growth that will allow me to retire by age 45. I working on getting a Roth IRA however this doesn’t allow for early retirement as you are penalized for withdrawal before 59.5

      If you don’t mind me asking, what type of investments are you investing in and at what age did you retire?

  2. Lisa

    Great article. This helps me out with planning future home buying.

  3. Minnie

    What if I have no credit cards or debt of any kind (and never have). Can I still get a mortgage?

    • Ben K

      Minnie: Yes, you can!

      It’s a (very) common misconception is that you can’t get a mortgage without having established your credit. In reality, if you have the right lender, they will do a manual underwriting procedure that looks at things such as income, payment history on utility bills, rent, etc. to establish your risk level. If you stay debt-free and responsibily manage your money, paying your bills on time and have stable income — you’ll have absolutely no problem getting a mortgage.

  4. Ninita

    In my experience, the payment date and the date the lender reports to the credit bureaus might be different. This can come into play if you make a large purchase on a revolving loan (i.e. credit card, I mean, who doesn’t love getting the points?) and plan to pay it off right away, because you don’t want your credit to reflect that you used more than 25% of your availble credit. Say you make the purchase on the 23th, and you pay it off on the 26th, well before your due date of the 10th. That’s all well and good, unless your particular lender reports on the 25th. In which case, that large owing balance will report and can be (even slightly) detrimental to your score. All that to say, it’s good to know when your lenders report.

    • jeremypeyton

      Absolutely true, Ninita! The credit report is a “snapshot” and may not show that something is paid off.

      If you know you’re going to be mortgage shopping, it’s wise to pay down/pay off the balances and wait for them to report as paid. Each lender reports differently, so it’s tough to know that unless you’ve contacted each one.

  5. melanieida

    Hi fellow Y-ers! I have a question about how closing a credit card would affect my score. I recently read my report, and the score is at 745, though I don’t see any records of late payments. I’ve had one card open, without a balance, for several years.

    Recently I’ve gotten interested in traveling more through airline miles. I applied for a new credit card to start collecting miles for a long awaited trip to Brazil, but then saw a different card that would provide more benefits. Would closing the first one (it has sat on my shelf, unactivated, for one week) and using the 2nd affect my credit score negatively?

    Never fear, I’m planning on being a smart fish, and paying the balance in full each month. :)

    • jeremypeyton

      Howdy! It could lower your score if it is the oldest card you have and you close it. Credit history makes up a portion of your score, so keep your oldest card open and use it to pay off some small amount monthly (Netflix, phone bill, etc.) so it continues to report as being used.

      If you don’t have more than three cards open, opening another one to get the rewards won’t hurt you if you pay it off.

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