Contrary to the perception that Credit is only for credit cards, it plays a major part in our ability to borrow money. In fact, it is used in many other places that you probably don’t even think of. For example, some employers check the credit histories of potential candidates as a pre-requisite to hiring. Be it renting a home or shopping around for a better insurance rate, credit histories are checked to make sure that you aren’t too much of a risk to cater to.
Your credit score, commonly known as the FICO score, is a vital indication of your “credit health” and can make a huge difference in what you pay for borrowed money. Therefore, it’s in everyone best interest to keep their FICO score as fit as possible.
So have a look at these 5 popular credit score myths that could do more damage than good, if you followed them.
Myth No. 1:
Never using or not having any credit cards will improve your FICO score
It’s true that not having any credit cards might help control your spending, especially if the lure of too much available credit is too tempting to resist, but it will not help your score. What you need to keep in mind is that the FICO score of someone who has managed his credit responsibly is more likely to be higher than someone who has little or no credit history.
Buying everything with cash will surely save you from paying interest, but it is not an ideal thing to do in terms of building a good credit history.
How it can cause more damage:
Having too little credit history can lower your score, and if you don’t have any accounts that are older than 6 months, you might never get a score at all. They feel that the history is just not enough or too little to generate a score on. If you have a long history that is not so perfect and have made up your mind to get rid of all those cards, you are loosing on a chance to redeem yourself. FICO scores take into account the good and the bad, and if you generate more good, your score will improve.
Avoiding paying interest does not mean that you can’t build up a solid credit history. Use your credit cards in small amounts, and pay off the balance every month in full, and on time. This way, you succeed in building a favorable credit history and continue to enjoy a no-interest life.
Myth No. 2:
High credit limits or large amounts of unused credit will lower your score
As long as you don’t use that credit and add to your debt, having high credit limits on your cards is actually a good thing. Your debt-to-credit ratio, which makes up 30 percent of your FICO score, is the amount of revolving debt (i.e. the credit card balances) in relation to the amount of available credit (i.e. the credit limits). This calculation is used by Credit Bureaus to determine your ability to manage the credit you have. Ideally, you’d want this ratio to be under 30 percent.
For example, let’s assume that you have 3 open credit cards with limits of $5000, $7000 and $6000, equaling a total credit limit of $18000. Your balance on one card is $1700, on the second card it’s $1200, and on the third it is $2100; equaling a total balance of $5000. So basically you have used $5000 out of the $18000 available to you, resulting in a debt-to-credit ratio of 28 percent. This is to say, that only 28 percent of your available credit is being utilized at this time. The higher the percentage, the more likely you could be considered overextended which hurts your score.
How it can cause more damage:
If you are keeping your credit limits low on purpose, what you need to realize is that you are hurting your debt-to-credit ratio by making your collective balance appear to be a large chunk of your total available credit. Increment in the credit limit – or decline in balance – results in a more positive score for you.
So using the example given above, if one of your cards raised your limit by $1000, with your balances remaining the same, your debt to credit ratio will come down from 28 percent to 25 percent. On the other hand, if you were to cancel your card with the $7000 limit, without paying down on the other balances of $5000 to counteract the loss of credit limit, your new ratio will be 46 percent. Think about THAT!
Myth No. 3:
Closing old account that you don’t use anymore will boost your score
It is true that having too many accounts can put a dent in your credit score, but by the time you realize that, it’s too late. The problem lies in opening too many accounts in a very short time span. And closing them will not help your score. Especially not with the older accounts. In fact, it could result in more harm.
How it can cause more damage:
Closing your oldest accounts will result in making your credit history seem shorter than it actually is. And when it comes to credit histories, size does matter. FICO looks at the age of the oldest account, the latest account and the average age of all your accounts when deciding on a length of your credit history. The history is 15 percent of your total score. Besides, closing these accounts would mean shutting the door on the untapped credit potential you have, which in turn makes your current debt appear larger. This is reflected in the debt-to-credit ratio.
Keep your old accounts, but make sure they don’t have any annual fees or costs associated with them. Also, hide the cards somewhere you won’t use them. If you still wish to close accounts for any other reason, close the latest one with the lowest credit limits.
Just be aware that it will not increase your score.
Myth No. 4:
Cancelling the card or paying off the balance will rid you of bad history
Your payment history makes up 35 percent of your FICO score and closing the accounts with less than perfect histories will not make the harmful information go away. While paying off the balance is a good thing and can boost other areas affecting your score, it will still not remove the dark marks highlighting your payment history.
How it can cause more damage:
Cancelling the account does not remove the late payments associated with it. What it does is, it affects your debt-to-credit ratio (unless you make payments on your other debt to make up as well) and it can also affect the length of your credit history, especially if it’s an old account.
If the adverse information is not correct, be sure to contest it. But if it has been reported correctly, the best thing to do is to pay the credit cards on time, even if it is the minimum payment. Use the card to start building a good solid history of making timely payments and eventually, it will have a positive affect on your score.
Myth No. 5:
Checking your credit report too often can hurt your score
Even though people generally don’t know this, but ordering your own credit report or score has absolutely no negative effects on your FICO score. What cause the harm are excessive credit applications, like home loans, car financing or new credit cards.
How it can cause more damage:
Unless you check your credit report periodically, there’s no way you can check for discrepancies. To maintain your score at its highest point, it is essential that you check your report periodically and make sure that all accounts and their information are correct. With identity theft on the rise, it is even more important in these times than ever.
Good info as always. Thanks for passing it along.