Beware bad advice...
Recently, a family member asked me (Laura) for some credit-card advice.
He's young and just starting to build his credit. He's worried about setting himself up for a solid financial future.
He spoke with an account manager who said that one of the best things you can do to build credit is always maintain a small balance on your credit cards rather than paying them off... but I knew that wasn't true.
When I quizzed some friends and coworkers, I was shocked to learn how many people believe it.
So today, I'm debunking three common credit myths. Not only are these myths costing you money, but they're putting your good credit at risk.
Let's start with...
Myth No. 1: I should carry a small balance on my credit cards.
Calling this terrible advice doesn't do it justice.
Some people think that you don't build credit history when you pay your balance in full each month and that you need to maintain a small balance to acquire history.
Just using your credit card builds history. And if you pay the balance off each month, that shows potential lenders you're responsible.
If you've followed this sort of nonsense advice, you're wasting your money and hurting your credit.
You'll owe interest on whatever balance you leave. While it may not be a lot, that will add up over the years.
And carrying a balance can actually hurt your credit, as it lowers your credit utilization ratio (more on this in a bit). This ratio is one of the key components when it comes to calculating your credit score.
So if anyone tells you to keep a small balance to "help" your credit, ignore them. Remember, most people working in banks are salespeople, like account managers and tellers. I know from experience that they get incentives to keep you as a customer and keep you spending. And their companies make money when you pay interest on your credit balance.
Don't line their wallets while emptying yours.
Myth No. 2: Checking my credit report/score hurts my credit.
There are two types of credit inquiries – "hard" and "soft."
A hard inquiry typically happens when you apply for a loan, credit card, or mortgage and the lender or issuer checks your credit. Although hard inquiries can impact your credit score, one won't do much.
If you're checking rates for something like a mortgage or a car loan (known as "rate shopping"), the hard inquiry shouldn't hurt your credit if you get a loan within 30 days.
However, if you're regularly getting hard inquiries and no loans, that will damage your credit as it shows you're likely a credit risk.
Then there's a soft inquiry. This type of inquiry includes things like employment verification or checking your own credit score and credit reports.
You should absolutely keep an eye on your credit. Nowadays, most credit-card companies will give you your credit score for free.
And you get one free credit report from each of the three major credit bureaus in the U.S. – Equifax, Experian, and TransUnion – for free each year.
Knowing your credit score helps you haggle for better interest rates on loans. And keeping track of your credit reports is the No. 1 way to catch identity theft.
Our sister publication Health & Wealth Bulletin has told readers for years that keeping an eye on your credit reports and score is vital to having healthy credit.
Myth No. 3: It's better to close a zero-balance credit card I don't use than to keep it.
This one isn't exactly a myth, but it's important to understand when you should and shouldn't close a credit card.
Closing a card will likely have some impact on your credit, but how much impact depends on factors like the age of the card and its credit limit.
You don't want to close your oldest credit card. A shorter credit history makes you look riskier to lenders.
This is where your credit utilization ratio comes into play. A credit utilization ratio is the measure of how much of your total credit you're using. To calculate the ratio, you divide debt by available credit. Let's say you have three credit cards. Here's what happens if you close the card without a balance...
You can see that the credit utilization ratio jumps from 23% to 30%. That might not seem like much, but even a ratio that's just a little higher can mean you're stuck with higher interest rates on loans and other credit cards.
Now, if you're paying an annual fee on a zero-balance card, you might want to consider closing it. Especially if you're not anticipating needing any loans in the near future.
Also keep in mind that companies can cancel cards – without warning – due to inactivity.
This happened to me a few years ago. The bank closed my card, only sending a letter after the card was closed. I was fortunate that my card was my youngest card, and the one with the smallest credit limit. So there wasn't much impact on my credit.
If you're worried about a card being canceled, talk to your issuer about its policies. And maybe use that card to buy a tank of gas once a month.
What are some other credit myths you've heard about? Share them with us at [email protected].
Have a great week,
Laura Bente & Amanda Cuocci
March 25, 2018