For how important your credit score is, misconceptions are rampant.
There are a number of things that people commonly think they know when it comes to their credit, but that it turns out aren’t true. These mistakes can result in a lower credit score, which can cost you money since lenders will often charge higher interest rates to those with lower scores.
These misconceptions persist despite the fact that credit scores are more easily available to consumers than ever. More and more credit card issuers are giving their customers
free credit scores. In addition, for more than a decade, credit reports from each of the big three bureaus — TransUnion, Equifax and Experian — have been available for free once a year, through
annualcreditreport.com. “I think people have a little better grasp on the basics than in previous years, but they’re just taking a cursory glance at their reports and some of the nuances of credit scoring are lost on them,” says Jeanine Skrowronski, a credit card analyst at Bankrate.
Here are five common credit myths:
Myth #1: It’s okay to max out your credit cards. Some four out of five Americans still don’t know that high outstanding balances are harmful to their scores, even if they always pay their monthly bills on time, and even if they pay the balance in full each month, according to a Bankrate survey.
This is because of something called your utilization ratio. Let’s say you have one credit card and the limit is $5,000. Since experts recommend spending no more than 30% of your limit, and less whenever possible, that means you shouldn’t have a balance, at any time during the month, that exceeds $1,500.
Why? A lower utilization rate shows lenders that you’re responsible when it comes to credit and won’t go wild and spend every single penny up to your limit. (One solution, if you always pay on time: ask for your credit limit to be raised, which will reduce your utilization rate.)
Myth #2: You need to carry a balance on your credit card. Carrying a balance on your credit card from month to month is not necessary to build credit. In fact, you could leave your credit card in your wallet most of the time and be building credit.
“You absolutely, positively don’t have to carry a balance,” says Skrowronski, who recommends paying your credit card on time and in full each month. The only thing you’re doing by carrying a balance is paying interest — and with the average national interest rate at 15% that can add up quickly.
Myth #3: You only need one account to have good credit. A single credit card will help you build a good credit score, but those who have a diversity of accounts have the highest scores.
“It’s hard to get a really strong score without a mix of credit,” says Gerri Detweiler, credit expert at Credit.com.
The people with the highest scores have both revolving debt, (for example, credit cards), and installment loans (for example, student loans, car loans or mortgages). This is because 10% of your FICO score, which is used by the majority of lenders, is comprised of the types of credit you’re using.
Yet, according to Bankrate, 70% of Americans didn’t know that having just one credit account has a negative impact on their score.
Myth #4: Closing accounts has no impact on your score. When you decide to close an account — say an old credit card you never use anymore — you could be hurting your credit score.
Why? “It’s going to effect your utilization ratio, particularly if you only have one card in your wallet or you have high balances on all your other cards,” says Skrowronski.
Your overall utilization ratio is calculated based on the sum of all your accounts. Let’s say you have five credit cards that each have a $5,000 credit limit, which gives you a total credit limit of $25,000. If you close two of these cards, suddenly your limit plunges to just $15,000. If you had balances of $10,000 between the remaining three cards, your utilization ratio would suddenly jump to 66%, well above the 30% recommended by experts.
If you do the math and figure your utilization ratio is in good shape, you could close the card. The account will still be listed on your account for 10 years and won’t damage the portion of your score that looks at the age of your accounts.
“Closing an account can sometimes really be in your best financial interest,” says Skrowronski, such as when you’re paying an annual fee on a credit card you never use or you’ve racked up debts in the past and want to avoid overspending. “But you may just want to cut the card up,” in some cases, she says, and unofficially close it.
Myth #5: Once you pay a bill in collections, it will no longer hurt your credit score. If you’re late in paying a bill and it goes to collections, that information gets routed onto your credit reports. This type of negative information is bad for your credit score and tends to stick around for a while. Even if you later pay the bill, the blemish will probably stay on your reports for a whopping seven years.
Your best bet: Pay your bills on time to avoid them going into collections.
Lauren Gensler
5 Common Credit Score Myths That Could Be Costing You Money
