5 Myths About Credit Cards That Won't Go Away
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The idea of evaluating a person's creditworthiness goes back as early as 1899, when Equifax (originally called Retail Credit Company) would keep a list of consumers and a series of factors to determine their likelihood to pay back debts. However, credit cards didn't make an appearance until the 1950s, and the FICO score as we know it today wasn't introduced until 1989.
Due to these timing differences, many U.S. consumers hold on to damaging myths about credit cards. Let's dispel five of these widely held but false beliefs and find out what to do to continue improving your credit score.
Myth #1: Closing unused cards is good for credit
Remember when United Colors of Benetton used to be all the rage and you shopped there all the time? Fast forward a decade; you don't shop there anymore, and you're thinking about shutting down that store credit card. Not so fast! Closing that old credit card may do more harm than good to your credit score.
Your length of credit history contributes 15 percent of your FICO score. If that credit card is your oldest card, then closing it would bring down the average age of your accounts and hurt your score. This is particularly true when there is a gap of several years between your oldest and second-to-oldest card. Another point to consider is that when you close a credit card, you're reducing your amount of available credit. This drops your credit utilization ratio, which makes up 30 percent of your FICO score.
What to do: Keep those old credit cards open, especially when they are the oldest ones that you have. Just make sure that you're keeping on top of any applicable annual fees and they're not tempting you to spend beyond your means.
Myth #2: Holding a credit card balance is good for credit
The amount you owe lenders accounts for 30 percent of your FICO score. The smaller your credit utilization ratio (the amount of debt you hold compared to your total available credit), the better your score. This means if you can avoid carrying a balance, you should do so. However, responsible use of a credit card allows you to buy big ticket items, such as a kitchen appliance or laptop, that you can't pay off all at once. So, sometimes you will have to carry a credit card balance. When you do, credit lenders recommend that you keep your credit utilization ratio below 30 percent -- the lower, the better. Keeping a low credit utilization ratio demonstrates that you're more likely to be able repay your debts, positively affecting your credit score.
What to do: Pay back your credit card balance in full every month as much as possible. When you're not able to do so, then seek to maintain a debt-to-credit ratio below 30 percent across all your credit card debts. (See also: How to Use Credit Cards to Improve Your Credit Score)
Myth #3: Paying the cellphone bill builds your score
Since some cellphone carriers may run a credit check to decide whether or not to approve you for financing, you may think that those cellphone carriers report your on-time payment history back to the credit bureaus. Payments to service companies, such as cellphone carriers, electricity providers, and natural gas providers, aren't reported back to the credit bureaus. (However, Experian does provide eligible renters the option to make their rent payments count toward their credit history.)
What to do: Don't sign up for a cellphone plan thinking you'll get a boost in your credit score. Do continue paying your cellphone bill (and all other bills!) regularly on-time. If your cellphone account were to be sent to collections, then the cellphone company would surely report that info to all credit bureaus.
Myth #4: Choosing a popular card will benefit you
A 2016 study of 20,206 credit card users by J.D. Power found that at least one in five credit card holders have a card which has fees or rewards not aligned with their actual purchase habits.
In the hunt for bigger and better rewards, 20 percent of credit card holders end up with a card that doesn't match their needs and would be better served by a different rewards card, or even one without any without rewards at all and a lower interest rate. Here's an example from the study: One of the reasons that 44 percent of airline co-branded card holders appear to have the wrong card is that those individuals aren't spending at least the necessary $500 per month to gain enough rewards to cover the average annual fee of $75. (See also: Cash Back vs Travel Rewards: Pick the Right Credit Card for You)
What to do: You don't just want to follow the crowd when choosing a credit card. Stack up your current credit card against others and figure whether or not it's time to find a new card more suitable to your lifestyle. Check out our guides on how cash back cards really work and choosing the best travel rewards credit card to find the card that fits your lifestyle.
Myth #5: Believing there's only one credit score
That free credit score on your credit card statement may not be the same one used by a lending officer reviewing your application for a mortgage or car loan. Did you know that there more than 50 different types of FICO scores? Lenders have several options to choose from depending on their industry and preferred credit reporting agency.
What to do: If you get a free credit score through your card, check with the card issuer whether or not that score is a FICO score and what type of FICO score it is. This will help you know whether or not you can do an apples-to-apples comparison with the one used by your lender. Also, inquire with your lender if they can give you a target range for your loan to be approved. (See also: FICO or FAKO: Are Free Credit Scores From Credit Cards the Real Thing?)
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Tagged: Credit Cards, bills, credit history, credit scores, credit utilization ratio, debts, fico, miles, myths, rewards
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