The Truth About Common Credit Score Myths
The Sources of Credit Scores
A credit report is a living record of how you’ve used credit over time, as economics education expert Barbara Flowers explained in an interview for an Open Vault post on credit scores. The report includes information about your accounts, balances and payment history. You can review your credit reports from Equifax, Experian and TransUnion for free once a week through AnnualCreditReport.com.
A credit score is calculated by applying a scoring model to information in one of your credit reports. Because the three bureaus may have different information, you do not have just one credit score. Lenders commonly use a score called FICO (for Fair Isaac Corp.), which has scores from 300 to 850, and higher is better.
This seven-minute video from our Econ Ed team walks through how your credit score is determined, including five factors used to calculate a FICO score.Since the FICO Credit Score video was produced, TransUnion, Equifax and Experian have switched to providing you with a free credit report every week.
Narrator: Understanding How a FICO Credit Score Is Determined, presented by Econ Lowdown.
A FICO credit score is the most common credit score used to determine loan eligibility and the interest rates a person pays. A credit score is a person’s financial story packed into a three-digit number, which indicates a person’s credit risk. Your credit score is based on information found in your credit report. A credit report is a loan and bill payment history kept by a credit bureau.
Financial institutions and other potential creditors use credit reports to determine the likelihood of debt repayment. Credit scoring companies use statistics to determine the risk associated with lending. They do not use data such as sex, age, race or religion to determine the likelihood of repayment. FICO (Fair Isaacs Corporation) and other credit scoring companies are always updating their formulas or models, and lenders choose which model to use. Even though FICO updates its formulas, it uses the same general categories in all models for the development of its credit scores.
Here are the categories FICO generally includes with a rough estimate of the emphasis placed on each category. Payment History accounts for roughly 35% of the credit score; Amounts Owed Relative to Limits accounts for roughly 30%, Length of Credit History accounts for about 15%, Frequency of New Credit accounts for roughly 10%, and Types of Credit Used accounts for about 10%.
Let’s quickly break down each category.
- Payment History takes into account any bills paid late, including how many are late, how late they are, how recent the most recent delinquency was and the total amount owed. This is where people can sometimes find themselves in trouble with credit. The good news is that, over time, older entries, including negative entries, disappear from your credit report, typically seven years for late payments and 10 years for bankruptcy filings. In a newer FICO model, lenders will see borrowers’ trended data for the past 24 months. They will be able to see if a borrower pays balances in full over time. This change will likely benefit those who are working to pay off their debts. But it could cause a drop in the credit score of people who have acquired more debt over that time.
- Amounts Owed Relative to Limits is your debt-to-credit ratio or your debt utilization. Say you have five credit cards, each with a $20,000 limit. That means you’ve got a $100,000 credit limit. You may only be using 10% of that, and that’s positive; however, if that means you’ve maxed out on one card, that’s negative. FICO’s most recent model places more weight on rising levels of debt, higher debt utilization and late payments. It also places more emphasis on personal loans. Regardless of the model being used, it’s important to keep your utilization low.
- Length of Credit History takes the average length of time you have had your credit card accounts into consideration. The longer history you have of making payments on time, the better your credit score.
- Frequency of New Credit is important because if you have a lot of newly issued credit in your credit history – whether new loans or new credit cards – lenders may be concerned about your ability to repay all of this new debt. Therefore, they will be less likely to lend you money.
- While examining Types of Credit used, lenders prefer to see that you are capable of handling different types of credit. So, someone who only has credit card debt will probably not have as good a score as someone who has demonstrated good payment habits on installment loans, mortgage loans and student loans, as well as credit card debt.
All of this is important because your credit score affects your ability to rent an apartment, buy car insurance at lower premiums, and obtain credit at lower interest rates. That’s right: A good credit score will save you money.
Here’s an example:
Kim and Lee are applying for a $10,000 loan. Both look like qualified candidates. They both live in the same city and work at the same company. Let’s see if their FICO credit score tells a different story. Kim pays all her bills on time and in full, she usually uses about 10% of her total credit limit, and she’s had the same credit cards since college. Lee, on the other hand, frequently forgets to pay his bills on time, he uses over 50% of his credit limit, and when he maxes out a credit card, he opens a new account. Who do you think would have a higher credit score, and as a result be more likely to obtain a loan with a better interest rate? That’s right – Kim would, because her credit score is closer to 800 while Lee’s is closer to 600. Suppose that Kim received a 5% simple interest rate on the $10,000 loan while Lee received an 8% simple interest rate. Over the course of a year, Kim would pay $500 in interest while Lee would pay $800 in interest. That’s $300 more interest than Kim. He could have saved or used that $300 to purchase something else. So, your credit score does matter.
Let’s recap. To maintain a good credit score:
- Pay all bills on time and in full. This, way you avoid late fees.
- Avoid opening new credit card accounts or installment loans.
- Keep your debt-to-credit ratio low.
- Don’t cancel your oldest credit cards as length of credit history is important.
- And, remember, monitor your credit reports.
By law each of the three credit bureaus, TransUnion, Equifax and Experian, must provide you with a free credit report every year. You can obtain these free copies by visiting: www.AnnualCreditReport.com. Remember each of these reports may vary slightly from the others. So, it’s important to check all three. While you can get your credit report for free from each of the big three credit-reporting companies every 12 months, you generally have to pay to get your numerical score. Free scores, however, are often available through financial institutions or nonprofit credit counseling services.
Now you understand a little more about how a FICO credit score is determined. Visit stlouisfed.org and the education resources for more information on credit and other topics.
Continuing Feducation brought to you by Econ Lowdown.
Now, let’s bust some myths.
Myth 1: Your credit score only matters when you apply for a loan.
Reality: Your credit can influence interest rates, financial flexibility and even housing rental applications.
Your score plays a role in many day‑to‑day financial transactions, as Lesson 6 in the “It’s Your Paycheck!” series on FRE.org explains. A higher credit score can qualify you for better interest rates on loans and credit cards, which can save you thousands of dollars over time.
For instance, someone with a credit score of 780-850 could save over $1,500 in interest on a five‑year auto loan compared to someone with a score of 640-659, as shown in the table below, which was compiled by the Federal Reserve Bank of Atlanta with results from the FICO Loans Savings Calculator.
| Score | Interest rate | Monthly payment | Total interest paid |
|---|---|---|---|
| 780-850 | 6.07% | $387 | $3,239 |
| 660-679 | 7.99% | $405 | $4,326 |
| 640-659 | 8.87% | $414 | $4,835 |
SOURCE: “Why Is Good Credit Important?” infographic from the Atlanta Fed on FRE.org.
NOTE: Sample FICO Loans Savings Calculator results are as of May 26, 2026.
Good credit may also open the door to better options for:
- Mortgages
- Exclusive credit card rewards
- Insurance premiums
- Housing rental applications
- Security deposits
Myth 2: Checking your credit score lowers it.
Reality: Soft inquiries do not affect your score.
Soft inquiries occur when your credit report is checked for informational or nonlending purposes, such as personal monitoring or background checks, according to an October 2024 blog post on the website of Experian, one of the three major credit bureaus. These checks don’t have an effect on your score, the post says. Hard inquiries, on the other hand, happen when you apply for new credit (such as a car loan, credit card or mortgage) and one such inquiry typically causes a small temporary dip.
Monitoring your credit report is not only safe, but also encouraged, as noted in the FICO Credit Score video. You can review your credit reports from Equifax, Experian and TransUnion for free once a week through AnnualCreditReport.com. Whether you’re actively building your score or simply keeping an eye out for suspicious activity, it’s always a good idea to be conscious of your overall financial footprint.
Myth 3: Income is part of your credit score.
Reality: Income has no direct effect on credit scores.
Credit bureaus don’t factor income into your score. FICO scoring looks at your credit behavior, using factors such as credit and payment histories, according to a March 2020 Experian blog post.
Lenders, however, take income into account: They want to know whether you can comfortably repay the money you borrow. When a lender considers offering credit, they ask the question: “How likely is this person to repay the full amount?” To answer, lenders rely on what’s known as the three C’s of credit, as a Federal Reserve Education lesson outlines:
- Capacity: Your ability to repay, based on factors including how much income you have compared to your existing debts. If debt takes up a large share of your monthly income, lenders see less capacity for additional borrowing.
- Character: Your reliability as a borrower, reflected through factors such as your credit history and score. These tell lenders how consistently you’ve handled credit in the past.
- Collateral: Assets that can back a loan if you’re unable to repay. For things like auto loans or mortgages, the car or home itself serves as collateral, reducing risk for the lender.
Income can influence your ability to qualify for loans and credit, but it does not directly affect your credit score, as the 2020 Experian blog post states. What does impact your score is how consistently you use credit and make payments.
Myth 4: You need to carry a credit card balance to build credit.
Reality: Paying in full each month still builds credit and is almost always the best option.
Nearly half of respondents to a 2023 U.S. News & World Report survey said they believed that leaving a small balance on a credit card boosted their score. It doesn’t, as the survey report noted. What builds credit is responsible use: paying your statement on time, and getting your debt down. Keeping a balance on your credit card by not paying the bill in full each month actually can come with risks.
Carrying a balance exposes you to compound interest, which can escalate costs quickly. To see how carrying a balance can turn small purchases into expensive long-term debt, take a look at this short video:
Male: Great pizza!
Male Credit Card: Is it worth $2,000?
Male: Huh?
Female: I didn’t say anything.
Male Credit Card: I did!
Male: Who are you?
Male Credit Card: I’m the credit card you just used to pay for that $2,000 pizza.
Male: What are you talking about? It only cost $9.95!
Male Credit Card: Yes, if you paid it off within the grace period, but you only pay the minimum due. And you’ve almost maxed out your $500 credit limit. Mostly on pizza and other impulse purchases. So, if you just keep paying the minimum, it will take you 267 months to pay me off. And all those little charges will wind up costing you $2,129! Based on an 18.9 annual percentage rate.
Female: Ha! We’d better enjoy this pizza! You’ll be paying for it for 22 years!
Female Credit Card: I wouldn’t talk if I were you.
Male: Who’s that?
Female: Uh, oh! That’s my credit card!
Female Credit Card: That’s right! And you owe about $3,000 on me.
Female: That’s not so bad, is it?
Female Credit Card: No, except you only make the minimum payments, too! That means you’ll be paying for that smart watch about two decades after it has gone out of style. By then, that $3,000 balance will have cost you $12,774! Based on your annual percentage rate, which is also 18.9%.
Male: So, you’re saying we shouldn’t use credit?
Male Credit Card: Not at all! Credit cards are a powerful tool when you let them work for you!
Female Credit Card: Credit cards are handy and safe for online purchases, and we can be a lifesaver in an emergency. We help you establish the good credit that will help you purchase important things, like a car or home.
Male Credit Card: Use credit within your budget and try to stay away from impulse purchases!
Male: Like food?
Female: And clothes?
Male Credit Card: It’s fine to use us for a special celebration.
Female Credit Card: Or to buy a suit for an important interview.
Male Credit Card: But remember to think before you spend and stay within your budget. Here are some simple guidelines for managing your credit.
- It’s OK to have credit cards, but manage them responsibly.
- And you really need to pay your bills on time.
- Keep your balances low on credit cards and other revolving credit.
- Pay off debt rather than moving it around to other credit cards.
- Don’t open a lot of new accounts too rapidly.
- And, finally, check your credit report often.
Male Credit Card: Remember, keep your credit working for you.
Female Credit Card: And not the other way around.
Myth 5: Closing a credit card improves your score.
Reality: Closing accounts often raises your debt‑to‑credit ratio and may lower your score.
It seems intuitive that closing a card you don’t use would reduce risk, but the math says otherwise.
Two reasons closing a card can hurt your score, according to a May 2024 Experian blog post:
1. Debt-to-Credit Ratio
This ratio, also known as credit utilization, measures how much of your available credit you’re using.
Example: if you have a $6,000 limit and carry a $3,000 balance, your utilization is 50%.
Since utilization can make up 30% of your FICO score, closing a card can increase your utilization overnight.
Example: Imagine two credit cards with $5,000 limits each. If you spend $1,000 on one card, your utilization is 10%. If you close the unused card, your total available credit drops, and the same $1,000 becomes a 20% utilization rate. It doubled without a change to your spending.
2. Length of credit history
Your credit history length contributes 15% to your FICO score, as the May 2024 Experian blog post notes. Closing an older card shortens your average account age, which can lower your score over time. Scoring models favor long, established histories because they show consistent financial behavior.
Key Takeaways
When you know what actually affects your score, you can build habits that strengthen your financial future.
How should you stay in control of your credit? Here’s a recap:
- Check your credit reports regularly using reputable resources like AnnualCreditReport.com.
- Keep your debt-to-credit ratio low.
- Pay your bills on time and in full whenever possible.
- Protect older accounts to preserve your credit history.
Like credit scores, credit doesn’t have to be intimidating. It’s simply a tool. And the more you learn how to use it responsibly, the easier it becomes.
For interactive, easy‑to‑understand lessons, visit FRE.org for videos, modules, and activities that make credit and economics straightforward.
Notes
- Since the FICO Credit Score video was produced, TransUnion, Equifax and Experian have switched to providing you with a free credit report every week.
This blog explains everyday economics and the Fed, while also spotlighting St. Louis Fed people and programs. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.
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