I’ve been hearing and reading some strange advice regarding credit scores lately. Some of it is so widespread that it’s created a lot of confusion and leading consumers to make bad financial choices for the sake of improving their score. It’s important to understand how credit scores really work, what it means, and how to adapt your lifestyle to optimize it.
And for that to happen, these 9 myths need to go away and never come back…
#1 Having more credit cards will improve your score
My sister got conned into applying for a store card with this line just a month ago. She was declined and her credit score went down.
First of all, this advice could be true for some. Part of the calculation for credit scores include credit usage: your balance to available credit ratio. Additional credit cards could theoretically increase your available credit which can improve this part of the score. However, requests for new credit also reduces your score as well (for about 90 days), so the effect would be delayed regardless.
So the truth is, while you need to pay attention to your credit usage ratio, adding new cards is probably the worst way to do that. You could instead, ask your current credit card company for a credit limit increase. Or (even better) watch your spending and focus on paying down debt instead.
#2 You need to keep a monthly balance to develop a credit history
This advice is 100% wrong and, if you’ve fallen for it, is costing you money. Credit card companies report your balance once a month. It doesn’t matter if the balance is new purchases or from last month’s carryover. The only thing you need to do in order to build a positive credit history is use credit and make payments on time.
It is possible to make a purchase on a credit card and pay it off before the balance is reported to credit agencies. But that shouldn’t deter you from paying your balance in full each month. Bottom line: If you’ve been duped into carrying a balance for the sake of improving your credit score, it isn’t helping, and it’s costing you (likely) a high rate of interest.
#3 Credit scores are a measurement of trust
This one is for employers. Credit scores can sometimes be used by employers as a measurement of trust with money. The prevailing argument is that if someone has a bad credit score, they’re less trustworthy to manage company funds/perform accounting tasks. The problem is, that’s not what credit scores attempt to measure.
Not only has these assertions been empirically proven to be false, but a number of pieces of legislation around the country include the banning of the practice. For now, however, it seems to be a growing problem.
#4 Marriage merges credit
We answered an email recently dealing with this exact issue. When two individuals are married, their credit histories remain separate. The only way their credit scores can affect one another is through any joint accounts they might have or open. Then only those accounts become a part of both of their credit histories and will affect their individual scores as such.
#5 All credit scores are the same
There are three major credit reporting agency. Each company has their own credit history and each their own calculation of credit scores. There are also a number of third party formulas which can use any of the three credit reports. Each person likely has a number of “credit scores” as a result.
But it’s not the different scores that individuals should focus on. What’s more important to monitor are the three major credit reports. Differences, here, may mean reporting errors or blemishes that can bring down (some) of your credit scores and hold up your finances.
#6 Income affects your score
Credit scores are not a measurement of your ability to pay off debt as much as your trustworthiness of paying it back. As such, how much you make isn’t a part of the calculations for scores.
When you apply for larger amounts of credit like a mortgage or a car, if you are rejected or offered a lower interest rate due to your income to debt ratio, it has nothing to do with your credit score. You could have a perfect credit score and this would still be the case. It simply means you don’t make enough money compared to how much debt you already have to afford the loan.
#7 You should keep all old credit accounts open
This is more advice that can sometimes be true for some, but can also be a bad idea for others. Closing an old account can do 2 things to decrease your credit score:
- lower your balance to available credit ratio
- remove history from your credit reports
Those who use this advice fail to point out that the history is only removed after about 7-10 years or so (plenty of time to build an even better credit history), and that you could always ask for a credit limit raise from the accounts you DO use.
Keeping an account open just to have a higher available balance or because it will be removed from your history (years later) is not good advice – especially if you don’t monitor at the account. Hidden fees, changing terms, then interest and late payments can add up. Worse yet, someone could get a hold of your account and build up fraudulent charges and ruin your credit in the process.
There’s too many reasons it might be a bad idea to hold on to an old account and (really) not a single good one.
#8 Paying off debts will increase your score automatically
Even if the debts you are paying off are on delinquent accounts, you may not see an instant increase in your credit score. Late payments and other blemishes will still be in your credit history for at least 7 years. There are a number of reasons why this advice might not necessarily work for you.
It’s true, in some situations paying down debt can increase parts of your score (e.g. credit usage). But if you’re expecting to have a perfect credit score just because you paid off all your debt, you misunderstand how credit scores work entirely.
#9 Credit cards are the best way to build credit
This might be the most dangerous piece of advice on this list. But, ironically, it’s also the “most” true…let me explain:
Credit cards do make a very good tool for building a positive credit history. They have a flexibility that other types of good debt accounts lack. Credit card usage can be molded to your everyday spending habits, unlike car loans, student loans, and mortgages which are tied to an initial amount to be paid off over time. Not only that, but credit cards don’t require a major spending decision. So for someone looking to start building a credit history, they might be the best tool available.
That said, types of credit is a part of most credit score calculations. Having a number of different types of credit accounts is ideal. In fact, credit cards, might be the least important.
You don’t want to buy a house or car just for the sake of building your credit. In that way, credit cards make the best tool for the job, but they aren’t the best way to build credit.