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Last week we dove into the basics of credit and I thought it would be a good follow-up post to discuss some of the things I’ve heard about credit over the years that have turned out to be totally off base. This companion post to Credit 101 is looking to debunk some credit myths to make it more understandable and accessible.
If you haven’t read Part 1, head here to read it before getting into the nitty-gritty of this post!
As a quick reminder, there are 5 categories that make up your credit score, and each one has a different level of importance. These are the categories and the percentage they factor into the credit score:
– 35% relates to payment history
– 30% relates to amounts owed
– 15% relates to age of credit history
– 10% relates to new credit
– 10% relates to different types of credit used
Having good credit is all about getting good grades in each of these categories. To get a more in-depth recap, check out last week’s post!
But now, onto the myths!
Having a lot of credit cards will hurt my credit score
Fortunately, this is not the case. But first, some background with the help of those categories above. Credit card revolving utilization (do you need to take a nap yet?) refers to the amount of credit you have and how much of it you are using. Typically, you want to try and keep that pretty low because this factors into the amounts owed category that is one of the factors that goes into your credit score. This category contributes a solid 30% towards your score!
Let’s run through a quick example. Say I have 1 credit card with $2,000 credit limit and I have a $1,000 balance on that card. In that scenario, I am utilizing 50% of my credit, which banks don’t really like. A standard rule of thumb is not to go above 30% utilization, but I like to keep mine as low as possible, just to be safe. Having multiple credit cards raises your recommended utilization threshold because your threshold is based on your combined credit from all cards you have. If I have 2 cards with a $5,000 limit on each and a $1,000 balance, that leaves me with only a 10% utilization ($10,000/$1,000), which is a good thing for your credit score.
Applying for a new credit card will kill my score
Applying for a new credit card will help your score in that your credit card revolving utilization – the amount of credit you have and how much you are using – will go up, but the downside is that applying for a new card will result in a hard credit pull. This means the bank you applied for the card with reaches out to one of the credit unions and pulls your file to check your “credit worthiness”. No pressure, right? This falls into the new credit category above, which is only 10%. That new inquiry will drop your score by a couple points, but it’ll probably only be for a couple months. After two years, they will disappear completely. This myth is a bit overstated, as there is some benefit to a new card, like raising the utilization threshold, but there will be a slight initial drop.
Checking my credit will hurt my score
Because a hard credit pull will impact a credit score by several points, there is a lot of confusion out there about whether or not you can check your score with no negative consequences. There are two types of credit pulls and they are called, creatively, hard pulls and soft pulls. A hard pull is what happens when you apply for a card, or a loan, or anything involving a lender. That is the type of pull that results in an impact to your credit. Checking your own score, or performing a “soft pull” like those through Credit Karma, are totally fine. In fact, I regularly check several sites just to make sure everything is accurate and no random accounts are showing up. In this day and age, you can’t be too careful!
You should diversify your cards among all the big banks
While not a bad idea, this is a myth in the sense that nothing negative will come of sticking to one bank you trust. The only downside is if you are only all about Discover, a) there are a bunch of great travel/rewards cards you are excluding yourself from and b) depending on where you travel, Discover may not be accepted. Whenever I travel to Canada or outside the US, I always bring several cards with me, specifically a Visa card and a Mastercard, just to be safe (c’mon Discover, up your international game!).
If you overpay, your credit score will go up
I think this myth is an offshoot of credit card utilization, which we talked about above. Essentially, you shouldn’t use more than 30% of your available credit. So I think some people say, hey, if I make overpayments and have a negative balance, this will help, right? While there is nothing really wrong with overpayments, and I sometimes make them by accident, at the end of the day, there is no real benefit for you. The only way I could see it being useful is if you have a big purchase coming up and want to make sure you stay below the 30% threshold.
Debit card usage will help my credit score as well
Generally, the answer to this is no. Debit card usage does not help your credit score as there is no “loan” or “credit” involved. It is you spending money that you already have and the debit card just serves as the method of transfer.
Carrying a balance on your credit card helps your score
This is a something that I heard a lot when I was first researching credit cards, and I still read about it today! It is 100% wrong. Carrying a balance will not help your score, and will only result in you potentially getting hit by interest fees or late payments. Depending on your situation it might not be possible to not carry a balance, but definitely never carry a balance just to hope your score increases. Paying it off in full and decreasing your utilization will go a lot further towards helping your credit.
If you must get a credit card, only get one
I know plenty of people who are anti-credit, but they finally got that one credit card and they will be keeping it (and only it) for life! While I am a big fan of keeping your first card open the forever (read more about it here), there are plenty of different cards out there that might be a fit for you at different periods of your life. Business purchases, traveling, cashback – different cards cater to different needs, and your credit needs will change, so don’t be afraid to get more than one card. Just be smart about it!
If you don’t use your card anymore, close it
This is one of the simplest, yet biggest mistakes people make with credit cards. Instead of putting an old credit card away in a drawer, it’s easy to think along the lines of, “Well, I don’t want a hacker to get that number and buy a bunch of stuff at Walmart, so I’ll just cancel it”. This is a big mistake, and I am a huge fan of keeping your oldest card around forever. This factors into the 15% age of credit history factor, and your oldest card is a like a line in the sand saying, “I’ve had credit since 2012, you can trust me!”.
This is one of the hardest factors to build because time is the only thing that helps. As soon as you close your oldest card, that line in the sand is erased and it jumps up to your second oldest card, literally erasing your credit history with the click of a button. That can be a difference in years, and credit scores can be impacted. If possible, put a single recurring expense on that card, set it to autopay and keep it around for the long haul.
Credit cards are for people who buy things they can’t afford
Due to the nature of credit cards vs. debit cards, credit and credit cards can imply poor spending habits to some people. After all, the only people who need credit cards are the ones who can’t buy what they want with the money available on their debit cards, right? Well, that’s not quite the case. Credit cards have a lot of great benefits, including superior consumer protection against fraud and the fact that it builds your credit. Credit cards need to be treated wisely because the negative impacts are long-reaching, but they are superior to debit cards in almost every way.
The Simple Summary
Well, that was a pretty intense list of credit myths, so congratulations for getting through it! Knowing the truth behind those myths helped me feel a lot more comfortable and in control of my credit. Did I miss any or would you like more insight about anything in specific? Let me know in the comments section and I’ll get back to you!