Understanding the Basics: What is Credit?
Credit is essentially a measure of financial trust. It reflects your history of borrowing money and paying it back. It tells lenders how risky it would be to lend to you. It’s based on your borrowing habits, total debt, and payment history. Credit comes in three types: revolving, installment, and open. The most common type of credit is revolving credit, like a credit card. You have a maximum amount you can borrow, and you can use it again after you’ve paid it back.
Your credit score is a three-digit number loosely based on your credit reports. There are several different credit scores, but the most commonly used are the FICO Score and VantageScore. Your score can range anywhere from 300, which is very poor, to 850, which is perfect. It’s crucial to maintain a good credit score as it can affect your ability to rent a home, secure loans, and obtain insurance.
Myth 1: You Must Carry a Balance to Build Good Credit
The idea that maintaining a balance on your credit card helps increase your credit score is false. It’s always best to pay off balances in full and on time, whether on a credit card or an installment loan. It’s essential to understand the factors that influence your credit score. These factors are payment history, credit utilization ratio, length of credit history, types and number of credit accounts, and new credit applications. Carrying a balance will not positively affect any of these factors.
In fact, carrying a balance could harm your credit score. This is because one of the significant factors in determining your score is your credit utilization rate. Essentially, the more of your available credit you’re using, the lower your score will be. If you’re carrying a balance, you’re using up more of your available credit. This can lower your score, rather than boost it.
Myth 2: Checking Your Credit Score Lowers it
It’s a common misconception that checking your credit score causes it to go down. Fortunately, this is untrue. When you check your own credit score, it’s known as a “soft inquiry.” Soft inquiries do not impact your credit score. It’s only “hard inquiries,” such as when a lender checks your credit history when you apply for credit or a loan, that have the potential to lower your score.
Not only does checking your credit score not lower it, but it’s also an essential part of financial health. Regularly checking your score allows you to catch errors and notice signs of identity theft. It’s also a great way to keep track of your progress if you’re working on improving your score.
Myth 3: All Debt is Bad for Your Credit Score
Not all debt is created equal, and having some debt can actually improve your credit score. It all comes down to the type of debt and how you manage it. Credit cards, mortgages, and installment loans like student and car loans can increase your credit score if you make consistent, on-time payments.
The key to managing debt is to pay on time and in full. This demonstrates to lenders that you’re responsible with your borrowing habits. However, too much debt, especially unsecured debt like credit cards, can hurt your credit score. It’s best to keep a balance of different types of debt and to ensure you’re making all of your payments on time.
Myth 4: Cancel Unused Credit Cards to Boost Your Score
You might think that canceling a credit card you’re not using will improve your credit score, but this isn’t always the case. Closing a credit card can actually decrease your credit score by increasing your credit utilization rate. It also can shorten your credit history, another factor that credit bureaus use to calculate your score.
If you want to boost your credit score, it’s often better to keep unused credit cards open. Just be careful to avoid the annual fee trap, where you’re paying more in annual fees than you’re earning in rewards.
Myth 5: You Only Have One Credit Score
Most people believe they have just one credit score, but that isn’t the case. There are multiple credit scoring models used by lenders and credit bureaus. The most commonly known are FICO and VantageScore, and both use slightly different methods to calculate your credit score.
Even within each model, there are different versions and variations. Because of this, it’s possible that your credit score could vary slightly depending on which model and version are used. Don’t be surprised if you see slightly different numbers when checking your score!
Myth 6: Credit Repair Companies Can Always Fix Your Score
Although some credit repair companies are legitimate and can help you improve your credit score, they can’t do anything that you couldn’t do yourself. Most services offered by these companies involve checking your credit report for errors and disputing inaccurate information.
While some people may find it easier to hire a company to do this for them, it’s perfectly possible to do these tasks yourself for free. There’s no magic fix to improving your credit score, and any company that promises otherwise is likely a scam.
Myth 7: Co-signing Doesn’t Affect Your Credit
When you co-sign a loan or credit card, you’re agreeing to take on the responsibility of the debt if the other person doesn’t pay. This means that the account is listed on your credit report, and your credit score can be affected if the primary borrower misses payments or defaults on the loan.
Even if the primary borrower makes all their payments on time, simply having more debt listed on your credit report can lower your score. It’s important to realize the potential consequences before you agree to co-sign a loan or credit card.
Myth 8: Paying Bills On Time is Enough to Maintain a Good Score
While it’s essential to pay your bills on time, it’s not the only thing that matters when it comes to your credit score. Other factors like your credit utilization rate, the types of credit you have, your total debt, and how often you apply for new credit also significantly influence your score.
It’s crucial to take a well-rounded approach when trying to improve or maintain your score. Pay your bills on time, keep your credit utilization low, and only apply for new credit when you need it.
Final Thoughts: Establish Credit-Building Habits
In conclusion, becoming credit-savvy is all about understanding how credit works and committing to long-term, credit-building habits. Don’t fall for the common myths and misconceptions that could lead you astray. Educate yourself, make informed decisions, and watch your credit score climb.
Remember, it’s not about quick fixes but about creating and maintaining healthy financial habits. The road to excellent credit is a marathon, not a sprint.
