Credit Myth Busting, #3

Even if you are unsure about the behind the scenes mechanics, you probably have at least a basic understanding about how credit scores work. You likely know, for example, that paying your bills on time is an important part of earning and maintaining good credit scores. You likely also understand that negative events such as late payments, bankruptcy, foreclosures, and collection accounts can hurt your credit scores.

The sad fact, however, is that you probably have been exposed to a lot of credit myths along the way. If you have, it is probably not even your fault. There are a lot of self-proclaimed experts who perpetuate these credit myths. Unfortunately, believing credit myths can at the least leave you misinformed and at the worst might mislead you into taking actions which could damage your credit scores. There are so many credit myths floating around the cyber-world that I could write about them endlessly, but here are 4 common ones.

Credit Myth #1: More Debt Leads to Higher Credit Scores

You should reject any credit advice which leads you to believe that debt is good for your credit scores. You should especially reject this myth as it pertains to credit card debt. In fact, if your credit reports show that you incur large credit card balances then your credit scores are likely being damaged even if you make every single monthly payment on time. Typically one of the most actionable ways to improve your credit scores is to try to reduce your credit card debt, preferably to zero. Less is better…not more.

Credit Myth #2: Occasional Late Payments Are Not a Big Deal

NO!!! It is important to understand the purpose of credit scores. Credit scores exist to help lenders predict risk. The FICO and VantageScore brand credit scores specifically were created to predict the risk of you becoming 90 days late on any of your credit obligations within the next 24 months. When your credit reports show a history of late payments, even occasional, you will likely never be able to earn great credit scores.

Credit Myth #3: Your Payment History Is All That Matters

When it comes to your credit scores there is no question that the payment history on your current and past accounts is certainly important. However, the theory that your payment history is all that matters represents a dangerous line of thought. Payment history is actually only worth about 1/3rd of the points in your credit scores. That means that nearly 2/3rd of your credit score points have nothing to do with your payment history.

Credit Myth #4: Closing Credit Cards Is a Wise Move

If you have ever over utilized your credit card accounts in the past, the idea of closing those accounts in order to avoid temptation in the future can be appealing and tempting. You will even find a number of financial advisors who may advise you to do just that – close your accounts. Unfortunately, if you believe the myth that closing credit cards is a wise move then you could risk sending your credit scores into a downward spiral, one that’s hard to reverse.

Closing credit cards does not cause you to lose credit for the age of the account (that is another myth), but the account closure can still hurt you. When you close a credit card account you lose the available credit limit, a factor which matters when your revolving utilization ratio (the relationship between your credit card balances and available credit card limits) is calculated by a credit scoring model. If an account closure causes your revolving utilization ratio to increase then your credit scores will almost certainly suffer.