BUSTED: The Three Biggest Myths About Credit

Photo: Auzigog

While the difference between a 716 and a 700 may not seem significant, in the eyes of a lender
it could be the difference between approval and denial on a credit application. It could also result in a
few percentage points difference on an interest rate, which can translate to hundreds or thousands of dollars in interest charges over the life of a loan or credit card.

Credit scores are calculated from credit report information, and are a key factor in a lender or bank’s
decision to extend credit to a consumer.Since everyday credit actions, from using your credit card to paying monthly bills, can affect your credit score and access to financial products, it’s important to know some of the truths and misconceptions of credit health to help you navigate the trickier side to building your credit score:

Myth: Closing a credit card is always a bad idea.

Truth: Many credit experts advise consumers not to close credit cards because it shortens the average
age of your credit lines and raises your credit utilization rate (your debt divided by total available credit).
Both of those actions can lead to a drop in your credit score.

Closing a credit card can make sense in certain circumstances. If you have a credit card with an annual
fee, it might make sense to close that account even if your credit score will be temporarily negatively
affected. Be aware that the older the card and the higher its credit limit, the more negatively affected
your credit score will be if you close it. Make sure you don’t close your oldest credit card, and if you
choose to close a card, make sure you have other active credit cards in use.

However, if you are planning to apply for a loan soon, don’t close that credit card just yet. Knocking
a few points off your credit score before you apply for a loan may prevent you from nabbing a better
interest rate.

Myth: If I were richer, I could get a higher credit limit.

Truth: Lenders decide your credit card’s limit based on two factors: your income and your credit score.
Your income informs lenders what amount of credit you can afford to spend, and your credit score
indicates how reliable you are at making payments.

Lenders are likely to weight your credit score more than your income when deciding your credit limits.
Why? Because your creditworthiness is a better indication of whether you will repay your debt to the
credit card issuer. A consumer with a high income but poor credit score is likely to get a lower credit
limit, while a consumer with an average income but excellent credit is likely to get a better credit limit.
That tells consumers that a great credit score, not a high income, gives you a better shot at a high credit
limit. This is good news because you can build your credit score even if you can’t build your income.

Additionally, if you’ve recently built up your credit score, you may be able to increase the credit limit on
your current cards. If you have excellent on-time payment history and manage credit responsibly, credit
card issuers are more willing to extend credit to you. Call in and request a credit line increase, but be warned that the request may come with a hard inquiry hit.

Myth: Paying off a loan early will help/hurt my credit score.

Truth: Paying off your loan early won’t necessarily help or hurt your credit score.

Paying off your loan earlier than scheduled doesn’t hurt your credit score because paying the loan in
full won’t “close” the account and remove it from your credit report. Even when paid off, that loan will
remain as an account on your credit report for seven to 10 years, which means it affects your credit
history.

Furthermore, paying off a loan early won’t necessarily help your credit score either. Your credit score
is impacted by the on-time payments of your loan. The amount paid isn’t even reported to the credit
bureaus, so paying more towards your loans doesn’t affect your credit. The positive impact of paying
your loan off early is saving yourself on future interest charges.

However, being delinquent on your loan payments—being over 30 days late—will severely impact your
credit score. Even one late payment can drop your credit score upwards of 30 points, and a delinquent
account or an account in collections is even worse. Paying off a loan early may not boost your credit
score, but not paying your loan at all will wreak havoc on your score.

Bottom line: The key here is to be aware that your daily financial actions can impact your credit score.
Don’t commit any major financial changes, like closing a credit card or even applying for more cards,
without doing the research on how it will impact your credit. Some useful resources include using
CreditKarma.com’s Credit Simulator to see how actions could affect your credit score, and read online
resources like personal finance blogs, LearnVest, and Kiplinger to keep you in the know on money
matters that affect you.

Justine Rivero is the Credit Advisor for CreditKarma.com, the pro-consumer credit advocate that helps
more than 3 million consumers realise the everyday cost savings of having great credit health.

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