4 Common Credit Card MythsMarch 5, 2017
Most people have mixed feelings about credit cards. For some, they are a great tool for building credit. For others, they are the first form of consumer debt that many people incur. Although the majority of Americans own at least one credit card, a surprising number of people struggle with basic information about the terms, requirements, and the multiple ways they impact personal credit profiles. According to a recent survey from NerdWallet, most credit card users are unaware of the effects that many common actions have on their credit scores. More than half of consumers do not know when they begin being charged interest on credit card purchases, and 54 percent do not know that carrying a credit card balance does not help a person’s credit score. These findings support the idea that, while credit cards are widely used, the majority of Americans are unfamiliar with all of the information necessary to use them correctly. Here are four common credit card myths and why you should know about them:
Credit Card Myth #1: Carrying a balance is good for your credit score.
As stated above, more than half of credit card users think that the simple act of carrying a balance from month to month helps build credit. This is simply untrue — at a minimum, carrying a credit card balance often costs you money, and higher balances can actually lower your score by counting against your available credit. Users who only pay the minimum payment each month end up being charged interest on the average daily balance on the card. Increases in credit scores are influenced by factors such as maintaining on-time payments and keeping balances low compared to available credit limits (credit utilization ratio), both of which can be accomplished while still paying off your entire bill each month. Responsible credit card usage can help your credit score, but spare yourself from unnecessary fees and snowballing debt by only charging what you can afford to pay in full on time every month.
Credit Card Myth #2: The amount you charge to your credit card each month is not relevant.
Most credit cards come with a monthly limit. Many credit card users, especially first-time users, see that limit as the maximum amount they are able to spend that month and simply spending less the maximum is acceptable. While staying within your limit is important, the amount you charge to your card each month actually matters. When determining your FICO credit score, MyFico.com highlights how several factors are taken into consideration:
- Payment History (35%)
- Amounts Owed (30%)
- Length of Credit History (15%)
- New Credit (10%)
- Types of Credit Used (10%)
Amounts owed, which accounts for 30 percent of your credit score, is also known as your credit utilization. Your credit utilization is essentially the amount of your credit limit you use — the percentage of the amount you owe relative to the amount you have available. The lower the utilization percentage, the better — the higher the percentage, the worse effect it has on your credit score. For example, say you own a credit card with a $1,000 limit. If you charge $300 a month to your card, and pay it off, you will have a 30 percent utilization ratio, which will be good for your credit score. For a general rule of thumb, you want to stay at 30 percent or less of your overall credit limit.
Credit Card Myth #3: You should not accept a credit limit increase.
This one goes hand-in-hand with Myth #2. Many people believe that a credit limit increase is a way to get them to spend more money. While this could be true, accepting the increase can be advantageous as long as you are disciplined enough to maintain responsible spending habits. Suppose your bank offers you a $500 limit increase from your original $1,000, giving you a new limit of $1,500. If you keep your card usage the same by continuing to charge $300 a month, your credit utilization percentage will decrease from 30 percent to 20 percent. Therefore, accepting the credit limit increase can work in your favor and may help your credit score. On the other hand, if you tend to overspend and think you may be tempted to charge more to your card, declining the increase might be a better idea.
Credit Card Myth #4: Applying for a new credit card will damage your credit score for a long time.
When you apply for a new card, the bank will pull a “hard inquiry” in order to check your credit score before making a decision. Typically, these hard inquiries will result in a temporary dip in your credit score; however, they will only stay on your credit report for around two years. As long as you use the credit card responsibly and stay on top of payments, your new card can actually increase your credit score over time by adding to your credit history. However, try to stay away from applying for new cards too often (or within a short period), as this can have a negative effect on your credit score.
The Bottom Line
People have differing opinions on credit cards, and the abundance of misinformation surrounding them makes finding the right balance challenging. If you know all the facts, and how to use your card correctly and responsibly, they can be an effective tool for building good credit and help you be more likely to get the best rates on home loans, auto loans, education loans, and more.