5 credit myths you'll want to unlearn
Sign up for the free daily TPG newsletter for more credit card news!
Whether you're a credit newbie or a seasoned pro, it's important to know the facts when it comes to credit reports and scores. Bad information can lead to bad decisions. In turn, those bad decisions might cost you money or make it harder to qualify for credit cards and loans in the future.
Here's a look at five common credit myths you'll want to unlearn right away.
Revolving a balance on your credit cards will help your scores
Truth: Leaving credit card balances unpaid might damage your score.
You already know it's smart to pay off your credit cards in full each month to avoid expensive late fees. Yet you might not know that paying off your credit card balance each month could help your credit scores too.
When you leave an outstanding credit card balance from month to month, it might hurt your credit score in two different ways.
- Credit utilization. Credit-scoring models evaluate the percentage of your credit limits that you're using on credit card accounts (per your credit report). This balance-to-limit measurement is known as your "revolving utilization ratio," or "credit utilization" for short. When your credit report shows you're using a larger percentage of your credit card limit, your credit utilization rate increases — possibly hurting your credit score. Carrying an outstanding credit card balance might trigger an increase in your credit utilization rate. This is another reason why paying off your credit card balances in full each month is always a good idea.
- Number of accounts with balances: The number of accounts on your credit report with balances rolling forward can also impact your credit scores. Fewer accounts with outstanding balances is better from a scoring perspective. This isn't a major credit scoring factor, but it's worth knowing.
Your income influences your credit scores
Truth: Income isn't listed on your credit reports, so it can't affect your credit scores.
Credit-scoring models are designed to evaluate the information found on your credit report and predict the likelihood that you'll pay any account 90 days or more late within the next 24 months.
Lenders and credit card issuers may consider information outside of your credit report when you apply for new financing, but credit scores only take into account the data on your credit report. If you've checked your credit reports lately from Equifax, TransUnion or Experian, you may have noticed that the amount of money you earn doesn't show up. Since income isn't found on a credit report, it's impossible for your income to directly affect your credit scores.
Tip: You can check all three of your credit reports for free once every 12 months at AnnualCreditReport.com.
Paying a collection account erases it from your credit report
Truth: Paid collections can stay on your credit report for up to seven years from the date of default on the original account.
Collection accounts are considered a major derogatory item by credit-scoring models. They can cause major damage to your credit scores.
There are many reasons why you might want to pay or settle a collection account. Protecting yourself from a possible lawsuit is one reason. It may also make your credit look better to future lenders.
But paying or settling negative accounts won't erase them from your credit report. The Fair Credit Reporting Act (FCRA) allows collection accounts to remain on your credit reports for up to seven years from the date of default on the original account. Paying the debt doesn't speed up that seven-year clock.
Closing a credit card could help your credit scores
Truth: When you close a credit card, you may raise your credit utilization ratio. That could be bad for your credit scores.
Sometimes there's a valid reason to close a credit card account. You might not be getting enough value out of a card with an annual fee. You may need to close a joint credit card account during a divorce. But most of the time, you're better off leaving credit cards open if you can — at least as far as your credit scores are concerned.
Closing a credit card could reduce the total of all your credit limits, which in turn can raise your overall or aggregate credit utilization (aka, the balance-to-limit ratio on all of your credit cards combined). Anytime credit utilization increases, it could spell trouble for your credit scores.
Some people believe that closing a credit card will harm your credit rating by lowering the average age of your accounts. Since the age of credit is worth 15% of your FICO Score, it's better for your credit reports to look older. However, as long as the account remains on your credit report (seven to 10 years, depending on whether it's positive or negative), it will be counted in the average age of your accounts.
Employers can review your credit score
Truth: Employers may check your credit report, but only with your written permission.
You already know that your credit can have an impact on your ability to qualify for credit cards and loans (and the price you pay for those financial products if you qualify). But you might not realize that your credit could help you land a job.
Employers can't check your credit scores. Credit scores are used to predict the likelihood that you'll pay a bill 90 days or more late in the next 24 months. They don't predict whether you'll be a good employee.
Yet employers can check a version of your credit report if you give them written permission to do so. Positive credit history could help you to appear more trustworthy, especially if the job you're applying for is in the financial sector. Negative credit history, on the other hand, could be a red flag to prospective employers.
The condition of your credit can have a big influence on your finances. In fact, good credit could save you tens of thousands of dollars over the course of your life.
It's important to unlearn credit myths that could set you back. At the same time, you'll want to research how credit reports and scores really do work. Once you're saving money and getting approved for better credit products, you'll be glad you put in the extra effort.
Featured image by mixetto/Getty Images