Trying to sort out the facts from the myths about credit scores and credit reports is not easy. Should you open new credit card accounts or close them? Pay off all your balances every month or make regular payments to improve your score? The whole subject makes you want to throw your hands up and run far away.
In this blog post, you’ll find the most common credit myths explained from the lender’s point of view and get clear advice that will help you keep from damaging your credit score and your chance of being approved for a mortgage with the best interest rate available.
#1. “If I pay off my credit card balances to zero every month, it doesn’t matter how much I spend.”
Not true and here’s why: the timing of reporting credit card balances to credit bureaus has changed and that could lower your credit score if you follow this myth. What used to happen is a cards’ monthly billing cycle would close, and the credit card company would send your bill which you would pay – possibly in full. Then, at the end of the month, the credit card company would report your outstanding balance – zero – to the credit card company.
They don’t use this method any longer. The new way has the credit card company sending you your bill and the outstanding balance information to the credit bureaus at the same time. The credit bureaus report the outstanding balance on that card regardless of how much you’ve paid since receiving the bill. The high balance and the high minimum monthly payment that goes with it negatively impact your credit score as well as your debt-to-income ratio.
(Pro Tip – If you anyway pay off your credit card balances every month, pay them 2-3 days “before” you get your statement and not after. That way the statement will show a zero balance and the credit bureaus will also see a zero balance.)
#2. “As long as I pay on time, it doesn’t matter how many credit cards I have.”
There are a lot of reasons to not apply for a large number of credit cards, but the ones that impact your credit score are the most important. Issue #1: opening a new credit card, or getting any new credit for that matter, will lower your credit score. Credit scoring is all about predicting the future risk that you won’t be able to pay your bills on time. When you have new credit, there is no history to use in the risk calculation, so it’s counted as a negative thus lowering your score.
Aside from your actual score, underwriters also see the number of new accounts you are opening, and it worries them. They ask the same question that credit scoring is meant to ask – “how can we know they will be able to use this new credit card wisely AND make the mortgage payment they are requesting?” They see that you are making your payments on time, up to this point, but how much can you borrow before you aren’t able to make your payments as agreed?
#3. “Having multiple credit inquiries won’t hurt your score.”
When you apply for credit of any kind the creditor checks your credit report as a part of their decision process. These are known as “hard inquiries” into your credit, and they may lower your credit score by a few points, or don’t affect it at all. Examples of hard inquiries are applications for a:
- Auto loan
- Credit card
- Student loan
However, if you’re careless and allow multiple lenders to check your credit over a short period, it can damage your credit score. If you’re shopping for a mortgage and there are one or two inquiries from different lenders on your report, there will be little impact. Too many mortgage inquiries, or other “hard inquiries,” and your score could be lowered and negatively impact the interest rate you could get.
Other situations that can involve reviewing your credit are applying for insurance, a new job, getting utilities, or a new cellphone. These are known as “soft inquiries,” and they won’t affect your credit score.
#4. “I’m disputing a medical bill, but it won’t impact my credit report until it’s all resolved.”
Actually, that is not true. Whenever you are billed for a service or use a credit card to pay for something, and later disagree with the charge for whatever reason – that doesn’t stop the clock from ticking on a payment due. If it’s a medical bill that should be covered by insurance but, for some reason, the insurance company hasn’t paid yet, you’re still liable for the charges. If you’re disputing a bill with any creditor, like the service provider for your cell phone or a credit card company, you must pay the bill as agreed even while you’re disputing it.
If you don’t pay, whether on principle or by misunderstanding what you’re required to do, you will have a late payment reported to the credit bureaus. Late payments do significant damage to your credit score, and that damage doesn’t disappear once the dispute’s resolved. The payment was still made late and reported to the bureaus that way.
#5. “I may be young, but being on my parents’ credit cards for a few years gives me a credit history.”
Building your credit history and getting credit scores won’t happen until you have credit cards, a car loan or student loan in your name. You need credit issued directly to you by a creditor to begin building it. When you’re an authorized user on someone else’s credit card, they assume all responsibility for the timely repayment of the debt.
It’s essential that you start early to build your credit because you need time to show the credit bureaus and lenders how you handle debt. You can start with cash secured credit cards, making small, regular charges and paying them off over 12 to 18 months before applying for a regular credit card in your name. Lenders want to see how you manage credit. Actions speak louder than words – and seeing how you handle the credit you’ve been granted, over a substantial period, is what lenders look for and how you build a credit score.
The intricacy of what impacts your credit scores is something to learn and manage continually. It will help you protect your scores and make the best decisions that will keep them as high as possible. If you’re planning on applying for a mortgage loan soon, meet with a lender to discuss your credit as early as possible.