Your credit score is a valuable financial tool. A good credit score helps you get the best interest rates and be approved for premium credit offers. A bad credit score can make it challenging to get financing, and if you do get a loan, you’re stuck paying a high-interest rate.
Unfortunately, there are many misconceptions about your credit score and credit report. Believing these common misconceptions can actually hurt your credit score when you think you’re working on building it up.
Credit Misconception 1: You Need to Carry a Balance on Your Credit Cards
Carrying a credit card balance is one of the biggest misconceptions about your credit score that simply isn’t true. Maintaining a balance on your credit cards doesn’t help build your credit score and can actually hurt it.
Your credit score is calculated by considering five different factors, and one of them is credit utilization, which makes up 30% of your credit score.
Credit utilization is the amount of available credit you’re using. For example, if your credit card has a $1,000 limit and has $400 worth of charges on your card, your utilization rate is 40%.
Typical wisdom suggests you keep your utilization rate less than 30%, and some people even suggest your utilization rate should be less than 10%.
Interest that you’re charged on your credit card counts towards the utilization rate, so you’re using more of your credit than you would if you weren’t carrying a balance on your credit card and making interest payments.
Credit Misconception 2: Checking my Credit Report will Lower my Credit Score
It is commonly thought that checking your credit report will lower your credit score, but that is a myth.
Checking your credit report has no impact on your credit score. Checking your credit report isn’t a hard inquiry, so you don’t have to worry about your credit score decreasing.
In fact, you should be in the habit of checking your credit report once every quarter to monitor your credit score and ensure there are no inquiries or mistakes on your credit report that don’t belong.
Credit Misconception 3: Closing a Credit Card After Paying it Off Increases Your Credit Score
This is a common but dangerous misconception because closing your credit card can damage your credit score in two ways:
- It increases your debt-to-credit ratio (otherwise known as utilization rate) and
- Lowers the length of your credit history
As you know, your credit utilization makes up 30% of your credit score. Your length of credit history makes up 15% of your credit score.
If you want to have an excellent credit score, you want to keep your utilization rate low and keep your credit card accounts open for many years.
Credit Misconception 4: You Can’t Have an Excellent Credit Score with Only Credit Cards
Having a mix of credit types helps increase your credit score, but you don’t need multiple credit types to have a good or excellent credit score.
Credit mix accounts for 10% of your overall credit score. If you have multiple credit types (e.g., credit cards and a mortgage), you will have a higher credit mix score than someone who only has credit cards.
Your utilization rate, payment history, and length of history make up 80% of your total credit score and are far more critical to your overall credit score than your credit mix.
This means if you pay your credit card bills on time and in full every month, have a low utilization rate and lengthy credit history, you can quickly build an excellent credit score with only credit cards.
It is nice to have a credit mix, but don’t feel like you have to go out and get a car loan just to increase your credit score.
There are many misconceptions about your credit score and credit report. Understanding how your credit score is calculated and falling prey to the misconceptions on this list can damage your credit score.
With a poor credit score, you’ll be forced to pay higher interest on your mortgage and car loans (if you’re approved for loans at all).
Being aware of your credit score and actively working on building it is one of the best things you can do for your financial future.