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Dispelling some myths about credit scores

Many consumers recently have been wondering why their credit scores were lower than they thought they should be and what they could do to bring them up. To answer their questions, I talked to Ken Lin, who started Credit Karma a little more than two years ago. He ended up busting some myths, as well.

Myth No. 1

You have to be in debt to have a good credit score.

Lin calls this a big misunderstanding.

"People with scores above 800 have less debt than those with credit scores of 600 and 700," he said.

To get those near-perfect scores, they did everything right. Credit card bills were paid on time 99.9 percent of the time, their credit cards were older and they had a lot of cards but not a lot of debt on those cards. That last factor is called a credit utilization ratio, which is how much money you have access to vs. how much of that money you are using.

Lin suggests that you never use more than 30 percent of the credit you have available. He says people with perfect scores had an average of 6.7 credit cards, but they obviously weren't maxed out or even close. The average age of those cards was 10.24 years.

Lin suggests getting several cards and using them for the things you would normally buy, then paying off each card monthly. For instance, charge gas on one card, groceries on another and maybe your gym membership on a third.

The key is to use each card only once or twice a month for necessities and then pay on time, he says. By doing it this way, you don't overspend, you don't get in debt, and you make yourself a valuable credit card customer. You're showing that you have an active account that you can manage responsibly, Lin says.

Myth No. 2

Wealthy people have better credit scores.

Income is not a factor in credit scores, Lin says. Rich people don't always pay their bills on time.

Myth No. 3

If you don't have a credit history, your credit score will be poor.

Actually, no credit history means no negatives that can affect your score. You're given the benefit of the doubt, and Lin says you'll most likely start with a score in the 600s. After that, your score will go up or down depending on how you treat credit. Those whose scores are in the 400-to-500 range are not paying their bills and have otherwise shown a history of not handling debt responsibly, Lin says.

If you do have a low score, it's possible to raise it by 100 points or more in just a year if you:

• Clear up any outstanding debt and get current on your payments.

• Make sure all future bills are paid on time.

• Start establishing a new, better credit history by getting a secured credit card, which requires a cash deposit. That deposit acts as the credit line for your account. For example, if you put $500 in the account, you can charge up to $500.

Myth No. 4

It's better to have no debt at all.

Sounds great, doesn't it? Unfortunately, we live in a world where people need proof that you can pay your bills and that you can handle money wisely. Your credit score is used for many things by many people. In most states, auto insurers can use your credit score when figuring out how much you should pay for insurance. Potential employers look at it to see if you're under financial stress, which could affect job performance.

At some point, you'll want to buy a house, and a good loan depends on a good credit score.

You say, you'll rent all your life? Landlords look at your score, as well. So do mobile phone companies.

Lin says get a few cards, use them and pay them as suggested in this article, then pay cash the rest of the time.

You can find the answers to other questions on Lin's website (www.creditkarma.com). Remember, his site doesn't require your credit card number, because you aren't paying for anything. All information and services on the site are free; there is no up-sell. The company makes money through advertising. When you get your score, you'll be given suggestions on banks and companies with better loan options. You'll get several recommendations. The pool is not limited to Credit Karma partners and advertisers, Lin says. If the site software calculates that Wells Fargo has the deal that best matches your needs, it will recommend Wells Fargo even though the bank isn't an advertiser.

Dispelling some myths about credit scores 05/29/10 [Last modified: Friday, May 28, 2010 4:41pm]
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