Just Starting to Build Your Credit Score? Don’t Fall for These Credit Score Myths
Being a newbie in the credit world can mean making some mistakes in building your credit.
Not paying your credit card bill on time is the biggest mistake, and it’s a legitimate one that will cause a credit score to drop more than anything else.
Building your credit score early in life is important because lenders make decisions that involve your credit scores. Higher scores can lead to lower interest rates on credit cards and loans, so it’s important to work toward the highest score you can.
Falling for some credit score myths, however, because you don’t know any better as a new credit user can hurt your score. Here are three big ones to avoid falling for:
1. Debt is Needed for a Good Credit Score
Having high credit scores doesn’t mean you have to be in debt. Some people may tell you that you have to have a fair amount of debt to keep a credit card, and that you’ll need to use your credit cards often to do this.
This is wrong. You can still live debt-free with credit cards. A good credit score isn’t determined by having continual debt, but by paying down debt to a manageable level. Having too much debt will lower a credit score.
This is called credit utilization. It accounts for 30% of a credit score. It’s a good thing if done right.
Using up to 30% of your available credit, such as up to $3,000 of a $10,000 limit on a credit card, is about as high as you should go to maintain a good utilization rate and keep a score high. To get there, you’ll need to pay down your balances before the statement closing date of your account.
Another way to avoid high debt is to pay your credit card balances in full each month. And pay them on time. This will leave you with a low credit utilization rate.
2. Close a Credit Card to Improve Your Credit Score
Like many myths, this one sounds true because it sounds like common sense. Closing a credit card should lead to better credit scores because you’re using less credit.
That sounds true, but it isn’t.
In fact, the opposite is true. Closing a credit card account can lower a credit score.
The reason is simple and has to do with the first myth we busted. Having one less credit card lowers your credit utilization rate. That’s the percentage of your credit card limits that you’re using.
If you close a card that has a $5,000 spending limit, you’re losing $5,000 in available credit and your utilization rate will increase.
Suppose you have two cards, each with a $5,000 limit. With one card closed your limit drops in half and you have less available credit to use. That’s good, in part, because you can’t spend something you don’t have.
Then suppose you have a $2,500 balance. Your credit utilization ratio with just one card is 50%, which is very high and will cause a credit score to drop. With two cards your utilization ratio would have been 25% because you had a $10,000 limit on the cards. That’s below the recommended credit utilization rate.
If you close a card and never take on the extra debt that it allowed you, that’s a good thing. But if your spending habits continue and you maintain a $2,500 balance on one card with a $5,000 limit, then your utilization rate will increase.
Keeping unused credit cards open will lower credit utilization.
3. Checking Your Credit Report Hurts Your Score
As a new credit card user you may hear the falsehood that checking your credit reports hurts your credit score and that you shouldn’t check them. Or at least you shouldn’t check them often.
Checking your credit, either by yourself or a potential lender, is called a credit inquiry.
Some can hurt a score. These are called hard inquiries and are commonly done in background checks and in credit approvals to look at your risk level. Hard inquiries can deduct points from your score and will remain on your credit reports for two years.
This is why it’s not a good idea to apply for a lot of credit cards in a short period of time.
A soft inquiry, on the other hand, doesn’t affect your credit scores. It isn’t seen by lenders or credit scoring models.
Soft inquiries are when you check your own credit or a lender or credit card company checks it to preapprove you for an offer. They also happen if you authorize someone such as a potential employer, though it’s worth asking if the credit check will be a hard inquiry.
You should check your credit reports at least once a year. Look for errors and work to fix any that you find. You can check your reports for free three times a year.