- Credit scores are important to your finances.
- Many people believe a common misconception about their credit scores.
- Believing this myth could cost you.
Have you fallen for it?
Understanding how to earn a good credit score is crucial for everyone because this score affects so many aspects of your financial life.
Most people or companies that you want to do business with are going to check your credit and make decisions based on how high or low your score is, so a lot more doors could be open to you if you have good credit.
Unfortunately, sometimes people believe incorrect things about how to earn good credit. And there's one especially dangerous myth that could end up costing you if you fall for it.
You can't afford to fall for this falsehood about earning good credit
One of the biggest myths about credit scores -- and one you absolutely cannot afford to believe -- relates to credit cards. Specifically, many people have the inaccurate idea that you must carry a balance on your credit cards in order to build a good credit history.
Now, this myth is somewhat grounded in truth. The reality is, you need to borrow money in some form in order to earn a good credit score. And for many people, having and using credit cards is a great way to develop a credit record that earns them a competitive score.
When you use your cards and pay them on time, this is reported to the credit bureaus which keep all of your data. The positive payment history you develop shows lenders you can be trusted and it has a big impact on your credit score since payment history is the number one most important factor in determining it.
However, just because you need to use your cards does not mean you must carry a balance from month to month. It is perfectly OK to charge items on your cards and pay off the statement balance in full.
Why carrying a balance isn't necessary -- or desirable
Carrying a balance on your credit cards is not needed to build credit. In fact, it could backfire if you allow your balance to get too large relative to your credit limit.
That's because the second most important criteria used to determine your credit score is your credit utilization ratio. That's the ratio of credit used relative to credit available. If you charge too much on your cards, you will end up with a high utilization ratio. Anything above 30% hurts your score. And ideally you will have an even lower ratio to raise your score.
If you are carrying a large balance on your cards, your credit utilization could easily be well above 30%, and this will result in a worse credit score than you otherwise would have had.
If you carry a balance, you will also get stuck paying interest on it. And credit cards have very high interest rates so this could cost you a fortune. One of the key reasons to try to earn a good credit score is to avoid having to borrow at high rates.
So, by carrying a balance to try to improve your credit score -- and condemning yourself to covering costly financing charges in the process -- you'll be guaranteeing you pay more than necessary to borrow when avoiding that fate was the reason to try to earn a good credit score in the first place. There's no reason to do that, so don't buy into the myth that carrying a credit card balance is necessary or desirable for building credit.
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