What’s your credit score? If simply seeing that question got your heart rate increasing as you scrambled for the nearest exit, you’re not alone. In fact, researchers have shown a correlation between symptoms of depression and high levels of consumer debt.
Here in Colorado, the average score of 689 is good (fair?) enough to earn a ranking of 12th out of the 50 states. Perhaps unsurprisingly, those with higher incomes also have good credit scores, which might explain why Colorado is on the higher end of the rankings. Credit scores also correlate with age. In that same research that ranked Colorado 12th, Millennials and younger members of Generation X tend to be more likely to have lower scores, while older Baby Boomers (55 percent of those aged 70 or older) tend to have scores of 780 or better.
Despite the wealth of data available, there are still a lot of credit myths in circulation. Here are five you should learn to recognize:
#1 – Student Loans Don’t Affect Credit
It’s true the amount of government-issued student loans in good standing isn’t factored in to your credit score. In fact, paying student loan payments on time every month can be one of the easiest ways for young people to establish a payment history, which is factored into their credit scores. However, those who don’t pay their loans for a significant period of time, or worse, end up defaulting, can definitely expect to see their credit trend downward. That’s why it’s very important for borrowers to try to get a deferment or forbearance if they expect to have a period of time where they won’t be able to make payments. And like most government debt (see: tax debt), it’s no myth that bankruptcy almost certainly won’t wipe the slate clean on your student loans.
Beyond that, there are other pieces of the myth puzzle that need to be sorted out. For instance, while the amount of your loans may not be factored into your credit score, it will be factored into your debt-to-income ratio (DTI). Your DTI is used to calculate your worthiness for a personal loan like a mortgage. If your DTI is too high, many banks simply won’t lend to you.
#2 – You Can Always Take a Loan Out On a 401(k)
Even though you have many decades before retirement, starting to save in a PERA pension or your PERAPlus 401(k) or 457 Plan is critical. Between the first contribution to your retirement account and your first post-career day, there will be an overwhelming temptation to use the nest egg you’ve saved up when it’s much too early. This is what is known in retirement security circles as “leakage.” In fact, according to investment giant Vanguard, a total of 1.2 percent of retirement assets leaked out of their accounts before their owners were ready to retire. While that may not sound like a lot, keep in mind retirement investments are measured in the tens of trillions of dollars.
The IRS has many rules that govern private retirement accounts like 401(k) plans, 457 plans, and IRAs. That’s for good reason. Money in a retirement account should be for retirement. Just because you’re allowed to take money out doesn’t mean you should. In fact, a loan on your 401(k) might end up being a double whammy if you can’t pay it back—negatively affecting both your present credit and your future retirement.
#3 – Credit is Free Money
It’s prudent to be very discerning when it comes to which lines of credit you open in your name.
Your credit score is made up of these components:
- Payment history (30%)
- Amounts owed (30%)
- Length of credit history (15%)
- Mix of credit (10%)
- New credit (10%)
If you openmany lines of credit in a short period of time, and then proceed to do a poor job of paying those bills on time, your credit score will plummet. The best policy for using credit of any kind is to only use it when you need it, make sure you can afford it, and make payments on time.
#4 – It’s Usually Better If Parents Co-Sign
If you’re young, have no credit, and need to buy a car, your parents might have to co-sign in order for you to get the loan If your parents co-sign, you become intrinsically tied to them financially for the length of the loan. If your parents are pretty responsible with money, have secure jobs, and expect to make the payments, it can be a great way to help you establish credit. However, if something unforeseen causes them to miss payments, it’s going to affect their credit scores and yours.
If you can avoid having parents co-sign, great. If you absolutely need them to do it, then make sure you and your parents are all well aware of the consequences of money mismanagement.
#5 – It’s Impossible to Fix Bad Credit
Finally, some upside to a myth. Fixing bad credit is far from impossible as long as you have a plan. Sit down with your bills, a calculator, and maybe a financially savvy significant other, friend, or family member, and figure out what you need to do.
FICO—the company that creates and determines credit scores—has some ways those with poor or fair credit can get back on track. The first and most important step is to check your credit report and make sure the information is accurate. By law, consumers are entitled to request a free copy of their credit report annually, so if you haven’t done that yet, do it now.
The other ways are simple in theory, but difficult in practice: get back on track with timely payments and start reducing your debt. It’s incredibly difficult to become more disciplined with spending, and oftentimes it requires making painful sacrifices. However, if you make a plan and stick to it, eventually you’ll start seeing results.
If you feel lost, there are professional credit counselors who can help. The Federal Trade Commission (FTC) has some great tips for those interested in finding a legitimate counselor. Just like any time you’re looking to hire a professional, make sure you do your homework. The FTC encourages consumers to carefully vet anyone you’re entrusting with your financial future.
Do you have any “favorite” credit myths? Leave them in the comments!