Your credit history, credit report and credit score are all intertwined and critical to your financial wellbeing. Unfortunately, the credit score is really the only one that gets glamorized, as best you can glamorize a piece of financial knowledge. My conclusion is that it’s because credit scores seem easy to understand, it’s a 3-digit number after all, and makes it simple to measure yourself against other people. The only problem it’s quite difficult to understand exactly how it’s calculated. In the last few years we’ve gained more access to both knowing our credit scores for free and learning a bit how the Coca-Cola formula-level algorithm that determines our scores works.
Even though there’s now oodles of information about credit scoring available from reputable sources (like myFICO), you might still be believing one – or all – of these common and completely fictitious myths about your credit score.
Myth 1: I should carry a balance on my credit card to improve my score.
NO! Sorry, was that at all vague? Let me repeat myself: NOOOOO!
There is never, ever a good reason to carry a balance on your credit card because it is not a requirement to improve your credit score. Let’s take a stroll down credit scoring lane to debunk where this myth came from and why you should ignore it.
There are five factors that make up your credit score, of those five factors the big two are: on-time payments (35%) and credit utilization (30%). On-time payments is pretty self-explanatory, while utilization is the fancy word for “how much of your total available credit limit you use each month.” For example, you have a $1,000 line of credit on your card and you spent $200. Then you were 20% utilized. The credit bureaus want to see that you’re using some of your available credit, but not too much. The ideal number is to use 30% or less of your total available credit limit, but the lower the better.
Here’s where things get tricky. Utilization isn’t being monitored all month, it’s counted when your statement cycle ends and you get a bill.
For simplicity’s sake, we’re going to say Nora owns a credit card with a $2,000 limit and the statement cycle ends the last day of the month. Nora bought concert tickets on the 12th that cost $175. When the transaction posted to her account on the 15th, Nora immediately paid it off. She then didn’t use her card again. Nora’s statement ended on the 30th and she gets sent a bill for $0. This bill also gets reported to the credit bureaus and they see it as Nora not using her card because she has a utilization of 0%. You would think that’s good because it means Nora doesn’t give into temptation and overspend, but what the bureaus see is that she isn’t proving her ability to responsibly handle credit either.
The ideal situation would be for Nora to have left that $175 charge on her card until the statement cycle ended. Then Nora’s credit card company would send her a bill saying she owed $175, but could pay the minimum of $25. Nora would then pay off the bill on time and in full for $175. That means Nora would’ve had just shy of 9% utilization (a great percentage) and paid off her bill in full so she doesn’t owe any interest.
It seems the misunderstanding of how utilization works is why people think it’s best to carry a balance month-to-month. You should never just pay the minimum and carry a balance. Always pay your bill on time and in full.
Myth 2: It’s best to get close to my credit limit and pay it all off.
The origination of this myth makes a little sense. Some people believe if they come close to maxing out their credit cards, but always pay the bills off, then that shows responsibility. Wrong. As we just addressed in the last example, utilization is 30% of your credit score. You want to keep that utilization at 30% or less of your credit limit (30 and 30 makes it simple to remember). Coming close to maxing out your card means you’re almost 100% utilized. Instead of helping, that’s just going to be a barnacle covered anchor on your credit score.
Myth 3: It hurts my credit score when I check my credit report.
It never hurts your credit score when you check your credit report. In fact, you should be checking your credit report from each of the three credit bureaus (Experian, TransUnion, and Equifax) once a year. You can do this for through by going through the government endorsed site annualcreditreport.com. You’ll never be asked for credit card information.
However, you may get what’s known as a hard inquiry on your credit report when you apply for credit, which includes: credit card applications, mortgages, auto loans, student loans and personal loans. Just because you might get a ding, that doesn’t mean you should refrain from applying.
Your credit score is not a trophy; it’s meant to be used to get you the best deal possible on financial products. But – that also doesn’t mean you should just haphazardly begin applying for credit cards or loans either.
Myth 4: Shopping around for a loan will hurt my credit score.
It is important that you always shop around when looking for a loan. Your goal is to get the lowest possible rate, so just assuming the first auto lender/mortgage broker/personal loan provider or student loan servicer gives you the best rate is misguided.
Don’t let any lender scare tactic you out of shopping around. The credit bureaus understand you need to do this and therefore take that into account when there’s a sudden rash of credit inquiries being reported. If you do all your shopping within a 14- to 30-days window, then it will only be weighted as one hard inquiry to your credit score. Credit cards are the exception. You can check if you’re pre-approved as long as the credit card company uses a soft pull, but outright applying for a credit card is never considered “shopping around” and will be a hard inquiry on your report.
In many cases a hard inquiry only dings your score by a handful of points – five or 10 – unless you’ve been applying for a lot of credit in a short period of time. Then it may be weighted as more.
Myth 5: Employers check my credit score.
Nope – employers do not check your credit score. However, employers may check your credit report. An employer could make a good estimate of your score based on the details outlined in the report, but they aren’t actually checking your score. This pull also won’t count as a hard inquiry to hurt your credit score. Usually, this only occurs when you’re starting a new job as part of the vetting process.