It’s no secret that an excellent credit score can impact your financial life tremendously. With it, applying for loans and receiving the necessary funds becomes much easier. Plus, the costs of those loans will be significantly lower. It can also improve your chances of being approved for an apartment and obtaining certain jobs.
However, many misconceptions also come with credit scores. These myths can lead you to second-guess your financial strategy and may even cause harm to your score. Before setting out to improve your credit score, take note of some of the more popular untruths told today.
Myth #1: Carrying a balance on a credit card will improve your credit score.
Carrying a balance on your credit card will not increase your score. This misconception stems from the fact that lenders and creditors do like to see activity on your credit cards. The reason being is that they want to know that you can manage credit responsibly.
Ideally, you should seek to repay your entire credit card balance monthly to avoid costly interest charges. An easy way to do this is to make a few small purchases throughout the month on your credit card that you can easily repay on time. Repeating this process will improve your credit score.
Myth #2: Having multiple credit cards will hurt your credit score.
The number of credit cards in your name doesn’t impact your credit score. Your score is a financial snapshot of how well you manage credit. If you maintain low or zero balances on those credit cards, it could improve your score.
However, having multiple credit cards with excessive balances will increase your total unsecured debt – likely leading to a drop in your credit score. Also, applying for several credit cards in a short period may cause lenders to believe you’re in financial trouble.
Myth #3: Closing credit cards will improve your credit score.
When most people pay off their credit cards, their first inclination is to close the credit card so they don’t risk the temptation to spend on it again. However, closing your credit card could cause your credit score to go down.
One of the areas that lenders review when approving you for credit is your credit utilization ratio (CUR). This ratio determines how much of your available credit you’re currently using. Ideally, your CUR should be under 30% - meaning you are only using 30% of your available credit.
For example, imagine having the following two credit cards.
Credit Card #1: Balance = $2,000 Credit Limit = $5,000
Credit Card #2: Balance = $0 Credit Limit = $3,000
In this example, your outstanding credit card balance is $2,000, and your total credit limit is $8,000. So, your credit utilization ratio would be 25% ($2,000/$8,000 x 100).
Since you have a $0 balance on Card #2, you decide to close it. Your outstanding credit card balance is still $2,000, but your credit limit decreased to $5,000. Your CUR is now 40% - putting you above the recommended 30%.
Keeping old credit cards open lowers your CUR, which improves your chances of getting approved for loans. You should try to only close credit cards if the temptation to use them is too great or if they have costly fees, such as annual fees, charged by the credit card company.
Myth #4: Your credit score determines whether you’re approved for a loan.
Your credit score does play a role when applying for loans, but it isn’t the sole factor.
Most lenders review many financial aspects when approving loans, including your current assets, monthly income, etc. Your credit score is a snapshot of your financial history, but it doesn’t tell the whole story.
More often, lenders use your credit score to determine pricing. The higher your score, the less interest you’ll be charged because the lender views you as a lower risk when lending you money. If your credit score is lower, you can still be approved for a loan, but you’ll likely pay more interest.
Myth #5: Paying off debt too quickly can hurt your credit score.
This is more of a partial myth. The argument here is that if you repay your debt quickly, you’ll have fewer on-time payments recorded on your credit report. While this may be true for installment loans, such as auto loans or mortgages, it’s always in your best interest to repay outstanding debts as quickly as possible. Doing so will improve your overall financial well-being and cause you to pay less interest.
Fortunately, you can still log on-time payments and boost your credit score even if you paid off your installment loan(s) early. Again, use a credit card to make small purchases throughout the month that you can easily repay on time. Repeating this process monthly will help improve your credit score without paying unnecessary interest charges.
Myth #6: Your income level affects your credit score.
Your credit report and score are comprised of your current and past debts. Nowhere on your credit report is your income level noted, and credit bureaus are not given this information. That is why your lender will request copies of your paystubs when you apply for a loan – they cannot get this information from your credit report.
Myth #7: Checking your credit will hurt your score.
These days there are a multitude of apps and websites that allow you to check your credit score. Doing so should not affect your score. Most apps and websites pull your credit using a "soft inquiry." Soft inquiries are not recorded on your credit report. In fact, lenders often use this information for pre-approved offers they send out periodically.
The opposite of a "soft inquiry" is a "hard inquiry." A hard inquiry involves a lender pulling your credit report to approve you for a loan. This cannot be done without your approval. A hard inquiry will show up on your credit report and can temporarily ding your credit score. So, while checking your score will not impact it, applying for loans frequently can. You should only apply for loans and credit cards when necessary.
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Your credit score and report significantly affect your overall financial health. It’s always in your best interest to take actions that will boost your score and, therefore, pay less interest on loans and credit cards.
If you have questions about improving your credit score or are interested in consolidating debt to repay high credit card balances quicker, we’re ready to help. Give us a call to get started today.