As much as credit cards have become a staple of contemporary life, they can also be a major source of confusion given the misinformation that has persisted about revolving lines of credit. To further complicate the matter, some of the finer points about credit card use can seem to run counterintuitive to our logical expectations. In the spirit of the season, we’re resurrecting some of the most frightful misconceptions about credit cards so that we can put them to rest for good:
You’re better off avoiding credit cards entirely: Anyone who buys into this may face disappointment and frustration when they want to take out an auto loan, get pre-approved for a mortgage or even rent an apartment. The truth is that responsible credit card use is one of the most viable ways to establish and build your credit history, as it demonstrates reliable repayment of debt. What’s more, ten percent of your credit score is actually determined by what’s referred to as your credit mix. Successfully maintaining a balance of different types of debt, including revolving credit, factors favorably into this equation. To gain a fuller picture of how your credit mix affects your overall credit profile, check out “Credit Score Factor: Credit Mix. How a Little Diversity Can Help Your Credit Score.”
If you qualify for an elite membership card, you can spend as much as you like: Although a company may not disclose spending limits on their “exclusive” credit cards, you can be certain that these cards don’t, in fact, provide unlimited spending power. Credit cards with no-preset spending limits (NPSLs) have credit lines which aren’t publicized but vary according to each person’s individual credit and other unique financial factors. Instead of credit limit increases, these cards adjust your limits according to your spending and payment patterns. The obvious disadvantages of NPSL cards? It can be hard to predict what your credit limits are, or when your card may be declined.
You can prevent late payment penalties as long as you send the creditor something: If you make less than the minimum payment by your account’s due date, it’s handled as a missed payment by your creditor. This usually entails a late fee, and your interest rate may rise dramatically at 60 days past due. And as Consumer Education Services Inc. points out, you won’t be in a strong negotiating position to get the company to reduce your rate once you’re hit with penalties. In addition, missing even one payment can lower your credit score by as much as 100 points if you don’t make the late payment before it is 30 days past due (60 days in some cases). If you find yourself short on cash to meet your minimum payment obligation, it’s a good idea to call the company to let them know when you’ll be making your payment. In some cases, you may be able to get them to extend your due date.
Carrying a balance on your credit card will improve your credit: According to USA Today, approximately 43 million Americans, or more than 1 in 5 credit-card users, believe paying less than the full balance on their credit card will actually contribute to a higher credit score. When you consider that the card issuer generates revenue from the interest that compounds from an unpaid balance, it’s understandable that some people might believe creditors could be motivated to reward them for not paying off their account in full each month. But this simply isn’t the case. In fact, it’s a costly mistake that if left unchecked, costs consumers substantial money in interest and may negatively impact their credit standing by raising their utilization rates.
Credit utilization measures the amount of available credit you are using as compared to what is currently available to you. In other words, it’s the ratio of your outstanding credit card balances to your credit card limits. For instance, if your balance is $500 and your credit limit is $1,000, then your credit utilization for that card is 50 percent. In terms of your overall credit profile, utilization makes up about 30 percent of a credit score. Generally speaking, the lower this metric is, the higher your overall score will be. It’s generally advisable to keep your credit utilization at 30 percent or below. If this ratio gets too high, lenders perceive you as a greater default risk. For superb credit, you’ll want to keep your credit utilization below 10 percent. Camilo Maldonado, co-founder of The Finance Twins and contributor to Forbes, provides a clear explanation for how credit utilization is calculated: the outstanding balance on your revolving credit accounts is divided by the total credit available to you.
You should outright refuse to accept a credit limit increase: If your financial institution tells you that you are eligible for a credit limit increase, you might want to consider taking advantage of the opportunity. We don’t recommend this so that you can blow your budget on an expensive vacation or fund a large purchase. In fact, we would encourage you not to increase your spending once you accept a credit increase. This way, your credit will benefit from a lower debt-to-credit (credit utilization) ratio. As an example, a person with one credit card with a balance of $450 and a credit limit of $1,000 has a credit utilization rate of 45 percent. But if their balance remains the same and their credit limit is raised to $2,000, they will only be using 22.50 percent of their available credit.
But as The Balance cautions, be sure to fully assess the situation when using a credit limit increase as a strategy to strengthen your credit score. The trick is not to ask the creditor for the increase, but to accept the offer if it is made free and clear with no need to “get approved” or “qualify.” Although a hard inquiry on your credit itself will typically only impact your score by a few points temporarily, your credit issuer could actually lower your credit limit or even close your account if they run your credit and find that it has become problematic. Get solid information on when it makes sense to accept a credit limit increase here.
It’s best to close out old credit cards once you’ve paid them down: There are two good reasons you should think twice before canceling a credit card account after successfully paying off your entire balance. One, you’ll lower your total available credit, which will effectively increase your credit utilization if you have outstanding debt on other cards. Secondly, the length of your credit history comprises roughly 15 percent of your credit score. The longer an account has been open and active, the better it is for your credit, especially if the account has a healthy payment history. Get more insight into how credit history length factors into your overall score at myFico.
When it comes to managing your credit card debt and improving your credit standing, staying informed is a critical step. Don’t forget that The Police Credit Union now offers FICO® Score information for free to eligible members enrolled in Online Banking! After opting in to receive your score, you’ll have access to this valuable information online, along with key factors that affect your FICO® Score and other helpful resources. Get started by logging in to Online Banking and clicking on Account Services > See My FICO® Score. Find full details here.