5 Myths About Your Credit Score
Not the most exciting article on the site, but this is one of the most important ones. As a blog that talks so much about getting credit cards and all of the awesome things you can do with them, it would be irresponsible for me not to talk about things that can go wrong and important things to know about your credit. I think that one of the things that gets people in trouble with credit cards is not understanding the impact they can have, and how they work.
When you apply for a credit card the company will look at your credit score to decide if you are trustworthy enough to get one. (However, it's important to note that you know your self-control better than a credit card company does, so if you don't think you can handle the responsibility/temptation, you shouldn't get one!) Here are some of the misconceptions I had before I started learning more about credit cards and my credit score:
1. Getting a Credit Card Will Hurt Your Credit Score
If you spend too much money and are unable to pay it off, you bet it will! But if you are responsible and only use it for what you can afford, then pay it all off on time and in full, opening a new credit card can actually HELP your credit score! When you get a credit card, you are approved for a certain amount of credit. This decreases your credit utilization ratio, which is actually good for your score!
Credit utilization ratio is the amount of credit banks are willing to give you, versus the amount you are using. The less you are using the better, so if you can increase the amount they are willing give you, you can shrink your ratio without cutting back on your regular spending.
2. Closing a Credit Card Will Help Your Score
A lot of people think that once you pay off a credit card or decide to get another, you should close the one you have. Don't do this!! First of all, you're hurting your credit utilization ratio if you shut down that card. Another factor that influences your credit score is your account history. If you have a bunch of credit cards that you only had for a year or less, banks aren't going to want to keep giving you more.
Instead of closing a card when you are done with it, lock it up in your safe, and leave it there for a while. Leaving it to sit in your closet and age will help increase your account history, but you won't have to juggle using more than one card at a time. (Note: there are a few reasons that you would close the card instead of having it sit around for a while... One would be cards with high annual fees. A $100 or $400 annual fee may not make sense to keep paying on a card you don't use, depending on your financial situation.)
3. All Debt is the Same
This one is pretty straightforward... Different kinds of debt affect your credit score differently. If you have a mortgage because you own a house, that isn't as negative as debt from unpaid credit cards. It's okay to have some debt, especially if it's debt toward an asset that appreciates in value, and that you will someday own, like a house. As long as you are making your mortgage payments on time and in full each month, this type of debt is not bad.
Bad debt included bills you are unable to pay, and loans on things that depreciate, or lose value. Taking out a loan for a car, to pay for a vacation, or to pay for large personal expenses will definitely make your credit score take a hit. Credit card debt is some of the nastiest debt to have, because the interest rates are so high that they can quickly get overwhelming and trash your credit score. This is something to keep in mind when you make the decision to get a credit card; it can be a slippery slope that can ruin your credit if you don't take it seriously.
4. You Need a Lot of Money for a Good Credit Score
Many people think that to have a good credit score, you have to have a lot of money, but that isn't the case. Your credit score is based more on the reliability of your payments than the amount of money you have or spend. There are so many factors that go into calculating the credit score, but the amount of money spent is not one of them! Building credit can take a while, but if you pay on time and in full on all of your loans and credit cards, you can establish a strong credit even if you don't have a ton of money in the bank.
5. You Only Have One Credit Score
There are actually several credit scores, not just one. Your credit score is supposed to determine the likelihood that you will pay back your loans and how much credit you should be lent. Naturally, everyone thinks they know the best way, so there are quite a few out there. Banks or credit lenders can choose to pull from any of the credit scores, as they are all calculated slightly differently, therefore providing a different view of your credit history.
FICO scores are the credit scores people most often refer to. Even within FICO, there are several different versions that can be used. Another common credit score is VantageScore. This score was launched by the credit bureaus (Equifax, Experian, TransUnion) to provide an alternative to FICO scores. While those two tend to be the main ones, there are, of course, tons of other formulas for calculating credit.
Hopefully learning the truth behind these myths helps keep you from feeling so stressed when you think about credit cards and your credit score. It can all seem scary and very overwhelming at first, but the more you learn the less stressful it will be. If you're worried about getting in over your head with a credit card, check out our post on How to Stay Out of Trouble with Credit Cards! However, if you're feeling a little more reassured and think you're ready to get your first credit card, you can visit our Beginner's Guide to learn more or check out this article about a great card to get you started!