Published in: Credit Cards | Sept. 14, 2019
By: Christy Bieber
Do you really know how credit scores work? Here are six common myths many people believe -- but that could be damaging to your finances.
Your credit score is exceptionally important. A good credit score means you should be able to borrow at reasonable rates, qualify for great rewards credit cards, and take out loans for important purchases such as a house or a car.
Unfortunately, although most people know they need a good credit score, there are a lot of misunderstandings out there about how to actually earn one. And some of those myths and misconceptions could actually be very damaging to your long-term financial health.
You don’t want to hurt your financial situation because your behavior is shaped by misunderstandings about how credit scores work. To make sure this isn’t happening, read on to learn about six common misconceptions many people have when it comes to their credit.
Checking your credit is very important -- but there are many people out there who don’t do it often or ever because they fear that pulling their credit report could hurt their score.
Indeed, there are times when having your credit checked can be damaging. The problem arises when you apply for too much credit at one time. Each time you apply for credit, a lender puts an inquiry on your credit report that stays there for two years. If you get too many inquiries, your credit score will suffer.
However, when you check your own credit, you don’t get an inquiry on your credit report. Nothing happens at all when you check your own credit -- except that you can find out whether there are any mistakes on your report, or whether you’ve been a victim of identity theft.
You need to know what creditors are reporting about you so you can correct errors on your report and take action if someone has opened accounts in your name. If you don’t, your credit score could be much lower than it should be. You don’t want a low score just because you believed the myth that checking your own credit is a bad idea.
Remember that mention of inquiries above? Unfortunately, the fear of too many inquiries can actually make you reluctant to shop around to find the best rates on loans. This can in turn do serious damage to your finances if you miss out on a better credit card, car loan, or mortgage loan because you were too afraid to check the loan terms of multiple lenders.
You do want to be careful not to have too many inquiries on your credit report right before you take out a big loan. But this doesn’t mean you shouldn’t shop around for the best rates. You should ideally try to get rate quotes from multiple lenders that perform soft credit checks. Soft credit checks don’t result in inquiries on your credit report, so you don’t have to worry about your score being dragged down during the loan comparison process.
Even if you do need hard credit checks to comparison-shop, these will rarely hurt your score. If you have your credit checked multiple times in the course of pursuing the same loan, credit-scoring agencies will usually recognize this as comparison shopping and group all those inquiries together as one. As long as you don’t actually take out multiple new loans in a very short period of time, your credit shouldn’t suffer.
Another common misconception is that it’s a good idea to close a credit card you aren’t using anymore. After all, you may be afraid that lenders will be wary of you if you have too much credit available.
The reality is that closing an old credit card provides no benefit to your credit score -- and can actually hurt you. Closing the old account won’t make any negative remarks on that account go away, so any late payments you made on an old credit card will still be on record if you close the account.
Also, closing the account could increase your credit utilization ratio and reduce the average age of your credit. A higher average credit age is better for your score, as is a lower credit utilization ratio. This ratio is the balance used versus the balance available on your cards. So if you close an old account and reduce your available credit, your score is inevitably going to suffer.
Lenders like to see that you can use credit responsibly. This fact has some borrowers convinced that they need to carry a credit card balance so that lenders can see that they're making payments. Unfortunately, this can screw up your finances because carrying a balance on your credit cards can be very expensive.
Although you do need to make purchases on credit to build credit, there is absolutely no reason you would ever have to carry a balance to impress future lenders.
Instead, you can develop a positive payment history record by spending money and then paying off your balance on time and in full each month. Doing this will save you a ton on interest and keep your credit utilization ratio low, both of which are very good things.
It’s also commonly believed that carrying debt can help you improve your credit -- but this isn’t the case either.
It helps your credit score if you have a mix of different kinds of debt. Ideally, you’ll have some revolving debt, such as credit card debt, and some installment loans such as personal loans or mortgage loans. This shows you can be responsible about making payments to all different kinds of lenders.
But owing too much can still be damaging. In particular, we’ve already mentioned that carrying a high balance hurts your credit utilization ratio. Applying for too much credit at one time can also result in too many inquiries and a shorter credit history, which will damage your score.
There’s also another problem with owing a lot. Lenders look at your credit when deciding whether to lend you money, but also at your debt-to-income ratio. This ratio compares your debt payments to your income. If you owe too much relative to your earnings, you may be denied the chance to borrow even if you have good credit.
Finally, you may think credit problems aren’t a big deal because credit repair companies can step in to fix them.
These credit repair companies advertise all the time and promise they can resolve your bad credit. They can’t -- but if you fall for their lies, they’ll charge you a hefty fee.
The only thing that helps you to build a good credit score -- or to fix bad credit -- is to be a responsible borrower over time. Don’t pay bills late, don’t borrow too much, and don’t make other irresponsible decisions and you should be able to earn the score you deserve.
Now you know some of the common myths that can lead you to make bad decisions when it comes to borrowing. Avoid these mistakes and use credit responsibly so that you can earn the kind of high credit score that qualifies you for financing on the most favorable possible terms.
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