Many consumers misunderstand how credit scores work, often believing myths that can lead to misguided financial decisions. Some people think that checking their credit score will lower it, while others assume that carrying a balance on a credit card is necessary to build good credit. These misconceptions can result in unnecessary interest payments, higher loan costs, or even credit denials. Without a clear understanding of how credit scores are calculated and what factors influence them, individuals may unknowingly harm their financial health.
Knowing the truth about credit scores can empower you to make informed decisions and potentially save a significant amount of money. By understanding how scores are calculated, actively monitoring credit reports, and taking strategic steps to improve credit health, consumers can put themselves in a stronger financial position.
Your Income Affects Your Credit Score
One of the most pervasive myths is that your income directly influences your credit score. While income might affect your ability to repay loans, it is not a factor in calculating your credit score. The score is primarily concerned with your credit history—how you manage and repay the credit you've used. Factors such as your total outstanding debt, the length of your credit history, the number of credit accounts, and your payment history all play a part. The rationale is simple: creditors are more interested in your past behavior with credit rather than your income.
Checking Your Credit Score Will Lower It
Another common misconception is that checking your credit score will reduce it. This myth derives from a misunderstanding of hard inquiries versus soft inquiries. A soft inquiry occurs when you check your own credit score or when companies check it for promotional purposes. These have no impact on your score. Hard inquiries occur when a lender checks your credit for the purpose of making a lending decision. While too many hard inquiries in a short period can negatively impact your score, simply checking your own score does not.
Closing Unused Credit Cards Improves Your Score
Many believe that closing unused credit cards will automatically improve your credit score. However, this often has the opposite effect. Keeping unused credit cards open can help your score because of a factor called credit utilization. This is the ratio of your total credit card balances to your total credit limits. Closing a card reduces your total available credit, which can increase your credit utilization ratio and potentially lower your score. Unless you're paying exorbitant fees, it’s often better to keep unused accounts open to help maintain a low credit utilization rate.
Paying Off Debt Erases It From Your Credit Report
Paying off a debt does not erase its history from your credit report. Lenders want to see how you've handled credit over time. A closed account with a positive payment history can benefit your score for up to ten years. Conversely, negative items such as missed payments or collections can linger on your report for up to seven years. Paying off an account in collections can improve your report by changing the status to "paid" but it does not remove the negative history.
Carrying a Small Balance on Credit Cards Boosts Your Score
A persistent myth suggests that carrying a small balance on your credit cards helps build your credit score. In reality, it’s not necessary to carry a balance to improve your score. In fact, not paying your balance in full each month means you’ll incur interest charges and potentially increase your credit utilization. The available credit you have relative to your balance is what matters most when it comes to your score. It's always best to pay off credit card balances in full and on time.
All Debt is Bad for Your Credit Score
Debt is a broad term that includes both good and bad debt. For instance, taking on a mortgage or a student loan can actually help build your credit history over time when payments are made consistently on time. On the other hand, consistently maxing out credit cards or having many overdue bills can hurt your score. The key here is how you manage the debt rather than the type of debt you carry.
Settling Debts Will Immediately Improve Your Score
While settling debts can be a necessary and beneficial financial decision, it won't necessarily lead to an immediate improvement in your credit score. Settled debts remain on your credit report as a negative mark, indicating that you paid less than the full amount originally owed. This information can impact your score until it ages off the report. Over time, the influence of these markers lessens, but they don’t offer instant relief to your credit score.
Marital Status Merges Credit Scores
Getting married does not merge your credit scores; each individual maintains their own credit history and score. However, joint accounts and loans taken out together can impact both spouses' credit scores. It's crucial for couples to communicate about financial decisions and understand how joint ventures could affect their individual scores.
Once You Have Bad Credit, There's No Hope to Improve
This myth can be particularly disheartening for those who have struggled with credit in the past. The truth is, even if your credit score has declined, there are ways to rebuild it. Responsible credit behaviors like paying bills on time, reducing your debt, and avoiding new hard inquiries can gradually improve your score. It takes time and effort, but improving a poor credit score is certainly possible.
Credit Reports Are Error-Free
Many people assume that their credit reports are without error, but inaccuracies in credit reports are more common than one might think. Mistakes can range from incorrect personal information to inaccurate account details. It's vital to regularly check your credit report from all three major bureaus—Equifax, Experian, and TransUnion. If you find any mistakes, you have the right to dispute them and potentially improve your credit score.
Using a Debit Card Builds Credit
Debit and credit cards function very differently when it comes to building credit. While a credit card directly impacts your credit score, using a debit card has no effect because it doesn’t involve borrowing money. Transactions from debit cards are deducted from existing funds in your bank account, unlike credit, which utilizes borrowed funds that need repayment. If building credit is a priority, focus on using credit cards wisely by making small purchases and paying off balances in full.
Opening New Credit Accounts Always Helps Your Score
A belief exists that opening new credit accounts can boost your credit score by increasing your available credit. While increasing your overall credit limit can positively affect your credit utilization ratio, opening many accounts in a short period can be seen as an indicator of financial distress by creditors. Each new account also results in a hard inquiry on your report, which can temporarily lower your score. Being selective and strategic about opening new accounts is crucial for maintaining a strong credit profile.
Understanding these myths and truths can have profound effects on your financial health, especially when considering loans. Many find themselves paying higher interest rates on loans due to poor credit management based on misconceptions. Awareness and proactive financial behavior can make a significant difference in your financial journey. It’s essential to continually educate yourself, seek accurate information, and perhaps even consult with financial experts to better navigate the complexities of credit scores.
