We all know that your credit score is really important, so it’s no surprise that you’d want to increase your credit score whenever possible.
First, it’s important to know what your credit score says about you. It’s a measure of your creditworthiness. It’s not a measure of your wealth. It’s not a measure of how much you make. It’s simply a measure of how risky a borrower you are. Risky borrowers are ones that miss payments or default. Safe borrowers pay on time and have a long history of doing so. (You can see how your financial habits are affecting your credit by viewing two of your free scores on Credit.com.)
To help you better understand credit scoring, here are four myths around scores that are totally wrong.
1. Carrying a Balance Helps Your Score
Carrying a balance on a credit card means you don’t pay it off in full each month. As a result, you pay interest on the credit card debt, often in the double digits. Carrying a balance is not necessary for improving your credit at all.
Your credit card issuer generally reports your balance when the statement period ends. It doesn’t break it out into the balance you carry and the balance you accrued that statement period. If you spend $1,000, pay it off entirely, and then charge another $1,000 – your credit card company will tell the credit bureaus that you had two months with a balance of $1,000 and on-time payments.
If you spend $1,000, pay off $500, charge another $500 – your credit card company will tell the credit bureaus that you had two months with a balance of $1,000 and on-time payments. By carrying a balance of $500, you’re paying more in interest but with no real benefit to your credit score.
Carrying a balance will not increase your score, so pay off your statement each month if you can.
2. Your Credit Utilization Doesn’t Matter
If you’re close to maxing out on your credit cards, that’s a bad thing. Utilization is a measure of how much you’re using your available credit. Use too much, and you’re seen as a risk. Use too little, and you’re seen as safer.
You may note that utilization, which plays a role in 30% of your FICO score, has nothing to do with your income. Making extra money can impact your total credit limit, so use it to your advantage if you can get an increase on your credit limits, but the income itself doesn’t help utilization.
You could be making millions of dollars a year but your score could be lowered because you’ve utilized too much of your available credit.
3. You Only Need a Credit Card
Getting a credit card is a good start to building a strong credit score, but it’s not enough. You really want to have a mix of accounts, like a student loan or a mortgage, to show you can handle different types of debt. This mix makes up 10% of your FICO score.
You shouldn’t take on unnecessary debt with the sole purpose of building credit, but it’s important to note it’s hard to get a high credit score without it. An unsecured line of credit, like a credit card, is just a strong first step.
4. Paying Off Old Delinquent Debts Will Instantly Fix Your Score
We all make mistakes and perhaps one of yours is now a delinquent loan or a charged off credit card account. If you have the funds, it may be tempting to pay them off. And, in fact, it might be the best course of action, since unpaid debts can lead to a collections account, judgment or wage garnishment — and the first two of those three adverse actions can directly lower your credit score, while the last one can really hamper your finances in general.
Still, it’s important to understand that paying these old debts won’t automatically fix all your credit score problems. Most negative information remains on credit reports for seven years (some bankruptcies can stay on for ten) — and that includes delinquent accounts that have been brought back into good-standing. (You can go here to learn more about how long things stay on your credit report.)
And, if you pay off an old debt, it may restart the 7-year clock. So, yes, past mistakes can affect your scores for quite some time. The good news is, the effects they have on your credit will lessen over time. And there are things you may able to do in the interim — like paying down high credit card balances or disputing errors on your credit reports — that can raise your scores.
Image: Courtney Keating