Five misconceptions about credit that can hurt your credit score

Not sure if you are using your credit cards the right way? MagnifyMoney offers you some tips on how to change your credit strategy.  MagnifyMoney is a price comparison and financial education website, founded by former bankers who use their knowledge of how the system works to help you save money.

Credit cards are one of the trickiest financial tools to master. If you use a credit card and make a mistake, like missing a payment, you could see your credit score plummet. And yet, if you avoid credit altogether, you could find it hard to get approved for big purchases like a new home or even an apartment lease.

Unfortunately, banks rarely include a “How-to” manual with credit cards, and there is a ton of misinformation about the proper way to use cards.

Here are some misconceptions about credit that could hurt your credit score:

No. 1:  It’s safer to use a debit card or prepaid card to build up your credit history.

It’s impossible to improve your credit score by relying on a basic debit or prepaid card. Debit cards are linked to bank accounts and bank history is not reported to credit bureaus. Likewise, prepaid debit cards, which you can load with cash and use like a normal debit card, aren’t reported to credit bureaus either. 

That being said, credit cards are certainly not the only way to establish a credit history. If you have a mortgage, student loans, utilities in your name or even a cell phone bill, you likely have been building up your credit history over time.

If your credit file is super thin and you’re eager to build it up without taking on a huge amount of debt, there are steps you can take to build your credit wisely. Think about opening a secured credit card through a local bank or credit union.

Credit cards aren’t just important for building your credit history. They can also be a safer way to make purchases online or when traveling abroad. Credit cards have more extensive protections than debit cards if you are the victim of fraud.

No. 2: It’s good to carry a balance on your card each month.

One of the worst credit card myths out there is the idea that carrying a balance on your card from month to month is actually a good thing. This couldn’t be further from the truth. You do not need to carry a balance to have a good score.

The best way to improve your credit history (and your credit score) is to always ensure the statement balance on your credit card is less than 30% of your total available credit. Ideally, you would even keep that number below 10%.

For example, if you have three credit cards with a total credit limit of $10,000, the balances on those cards should never add up to more than $3,000.

Why?

It seems like a mean trick, but credit lenders typically extend credit limits that are way higher than a person might be able to pay off in full each month. Part of building up your credit score is proving that you are able to resist the temptation of using your entire credit limit without paying it off. 

If you max out your cards and aren’t able to pay them off, you’re only doing the lender a favor. They earn big money on the interest that you accrue each month on your unpaid balance.

No. 3: You should never have more than one credit card.

In some cases, especially if you are new to using credit, it can be wise to keep just one credit card. But using more than one card can actually be a good thing for your credit score because it increases your total available credit limit.

Remember, credit scoring agencies like to see high available credit limits and low credit balances.

If you can resist the temptation of maxing out every credit card you open, you can even take advantage of some lucrative credit card perks by diversifying your cards.

For example, you might use a credit card with a great cashback reward for gas and another card with great travel rewards for booking flights. This will take discipline, but if you work the system properly, you get to reap all the benefits of credit rewards without hurting your credit history at all.

No. 4: Opening a credit card will ruin your score.

It is true that applying for credit will result in a hard inquiry on your credit report, but it won’t ruin your score. At the most, you might lose about 10 points.

If you are shopping around for a mortgage and want to be sure your score is as high as possible, it would make sense to avoid applying for new credit during that period. But in general, you don’t have much to lose.

If you are still worried about those hard inquiries hurting your score, it might be possible to see if you pre-qualify for certain types of credit. Some major banks give you the chance to see if you are pre-qualified for cards before you officially apply.

You give a bit of personal information (name, address, last 4 digits of your social security), and they will tell you if you are pre-qualified. When they have your information, the banks only do a “soft pull” on your credit, which will not ding your score the way a regular credit pull would.

Here’s a list of banks that currently offer pre-qualification.

One word of caution: Avoid opening too many credit cards at once. Credit scoring models take into account the average age of your credit. Having a bunch of new accounts can lower your average age. 

No. 5: Credit limit increases are bad for your score.

Sometimes lenders offer credit limit increases to customers who are using their cards frequently. This can be a good thing or a bad thing, depending on how you react. If you take this as a cue to max out your cards immediately, then you’re only hurting your credit in the process.

But, if you can resist that temptation and continue keeping your balance low, you could actually improve your score. That’s because increasing your credit limit, like we mentioned before, will boost your available limit. And when you show credit scoring agencies that you can keep your balances much lower than your total available credit limit, they will likely reward you.

There’s a big difference, however, when you are personally requesting a credit limit increase. If you call your lender and ask for an increase, they will have to do a hard pull on your credit report, which can actually ding your score.

If you are approved, the extra available limit might be enough to balance out that drop in your score. If you are denied, then you’ve just dinged your score for nothing.

This is where it’s important to know your strengths and weaknesses as a credit card user. If you tend to run up balances that are much higher than you can afford to pay off, it might be wiser to avoid credit limit increases.

MagnifyMoney is a price comparison and financial education website, founded by former bankers who use their knowledge of how the system works to help you save money.


JOIN THE CONVERSATION

To find out more about Facebook commenting please read the
Conversation Guidelines and FAQs

Leave a Comment