With all the misinformation about credit scoring models, it’s understandable that many Americans are confused about what actions they should take to improve their credit profile. What’s surprising is that even seasoned financial professionals have been known to perpetuate many of these myths that can actually hurt your credit standing and your financial well-being. To help you cut through the noise, we’re dispensing with some commonly-held misconceptions:
Myth: You should carry a balance on your credit card to help establish credit
If it seems odd that this myth continues to persist, consider that a recent survey from NerdWallet found that 41 percent of Americans mistakenly believe that carrying a small balance on a credit card can increase their credit score. Not only does this cost them money in interest that will continue to compound each month, but it also adversely impacts their credit record by raising their debt-to-credit ratio. Also referred to as credit utilization, this ratio is simply the amount of debt you have as compared to your available credit. A higher credit utilization ratio means a lower overall credit score. For a fuller understanding of credit utilization and how it impacts your credit, visit “Understanding Credit Utilization” from The Balance.
Myth: Closing out old credit cards can boost your credit score, and it’s a good idea to do this before applying for a new loan
After you’ve successfully paid off the entire balance of your credit card, it may seem like a great idea to call the company to cancel your account. However, there are two good reasons not to do this. One, closing the account will effectively lower your total available credit. This can increase your credit utilization ratio if you have outstanding debt on other credit cards. Effectively, you’ll have a higher percentage of debt as compared to your available credit. Accordingly, your credit utilization ratio will increase and your credit score will likely drop.
Secondly, the length of your credit history determines 15 percent of your credit score. As NerdWallet explains, the longer an account has been open and active, the better it is for your credit, especially if you have a good payment history on this account. According to NerdWallet, this is why it’s nearly impossible for a young person to obtain a credit score higher than 800. Find more insight on this topic at “Credit Age: How Length of Credit History Affects Your Score.”
Myth: It’s best not to use credit cards at all
Even if you have a solid payment history in terms of installment loans such as your mortgage and car loan, steering entirely clear of credit cards can actually hurt your score. Having different types of credit and loans is actually viewed favorably from a lender or creditor’s perspective. In fact, ten percent of your credit score pertains to credit mix. To learn more about how credit mix impacts your score, check out “Credit Score Factor: Credit Mix. How a Little Diversity Can Help Your Credit Score.”
Myth: If you can’t pay a minimum balance on an account, you’re always better off making a partial payment
Of course, your lender or creditor is not going to turn down a payment that is for less than the minimum, but it would be a mistake to assume that this can prevent you from being assessed late fees or reported as delinquent to a credit bureau. After all, you would still be considered to be in violation of your agreement. What might help: contact the creditor before the payment is due to see if it’s possible to set up a payment arrangement or hardship program.
Myth: You shouldn’t check your credit too often because it can lower your score
What’s important to understand is that when you check your own credit report, it is considered to be a “soft inquiry” which will not impact your score. On the contrary, reviewing your credit is an essential step to financial health that can help keep you on the right track, catch errors and ensure that fraudulent accounts have not been opened in your name.
On the other hand, when a creditor or lender pulls your credit report in response to your application for a loan or credit card, a “hard inquiry” will be left in your file. Too many of these hard inquiries can lower your score, because, as Forbes explains, it may appear that you are having difficulty obtaining new credit or that you are overextended financially. At the same time, this should not stop you from shopping around for the best possible rates and terms on a mortgage. Multiple credit checks from mortgage lenders or brokers are generally counted as one inquiry if they are made within a short window of time.
In attempting to debunk some of the most common fallacies around credit, we hope it’s clear that the best strategies for improving your credit standing are actually a lot simpler than some would have you believe. What’s more, SFPCU has made it even easier with our FICO® Score Display. Free to eligible members enrolled in Online Banking, this feature gives you an instant view of your base FICO score. It also provides a wealth of information to help you interpret your score, understand the major factors affecting it and learn specific steps to take to improve your score. If you haven’t taken advantage of this feature yet, get started today by logging in to Online Banking and click on Account Services > See My FICO® Score.