Do You Believe the Biggest Credit Card Myths??

Which Credit Card Myths Do You Believe?

“The great enemy of the truth is very often not the lie — deliberate, contrived and dishonest — but the myth — persistent, persuasive and unrealistic.”

– John F. Kennedy

“The truth is that carrying a balance won’t help your score at all…but it DOES hurt your pocketbook.”

Myth #1: Carrying a Balance on Your Credit Card Helps Your Score

This myth has become very popular.

In fact, there are so many people that believe this myth that when they ask for advice, their peers confirm it to be true! Even many bankers and loan officers help spread this fiction.

And the reason is probably because people who carry a balance “feel” like they’re using their card, which “feels” like it’s helping their score.

The truth is that carrying a balance won’t help your score at all. In fact, if the balance is considerable, it’ll actually hurt your score (see Credit Card Impact: Huge Factor on Credit Scores).

Carrying a small enough balance on your card won’t hurt your score, but it won’t help it either.

And most of the time, carrying a balance will actually cost you considerable interest charges. This doesn’t hurt your score, but it DOES hurt your pocketbook.

That’s why there’s zero benefit to carrying a balance on your card. In fact, you should do the opposite and pay it off each month. Your wallet will thank you.

Myth #2: Closing Old Cards is GREAT for Your Credit Score

Actually, the opposite is true.

For starters, you should NEVER close your credit cards. We’ll get into that in just a bit.

First, let’s briefly discuss why some people stop using their cards. The most common reason is usually because the introductory promo (e.g. no interest for 12 months) has ended. So, they figure they don’t need the old card anymore, especially if they just got a brand new card with a promotional interest rate. Nothing new here. We humans always want something that’s newer and shinier. If something is old, we’re less inclined to care about it. But there’s a difference between not using a card and actually closing one.

People close cards for different reasons. Sometimes, the reason even sounds rational. Some people don’t trust themselves not to charge their card. In other words, they’re spending addicts. These people figure that if they eliminate the temptation to use it, they won’t rack up debt. Hence, they close their old cards. This strategy might be necessary for those with a spending addiction, but most people can manage to keep their old cards open without using them. If you aren’t a spending addict, then keep the cards open.

Then there’s some folks who think that closing a credit card is actually good for their credit scores. They figure that if they close the card, they’re demonstrating financially stability. Why? Because they think that by demonstrating their ability to live off of cash and debit cards (and not credit cards) makes them a lower credit risk. It doesn’t.

Here’s another good one. Many people think that any “credit risk” will hurt their scores. In a manner of speaking, they’re somewhat correct. If you have new risk (e.g. new loans or new credit card debt), your credit score will be penalized. However, some people twist this notion. Some believe that creditors look down on people with lots of available credit. They assume that less available credit presents less risk for the creditor. Therefore, they mistakenly think they can eliminate the risk by closing the card (More on this in myth #3 below).

Let’s look at the facts.

There are two reasons closing cards hurts your score.

  1. Scenario: You have no open accounts (that means no credit cards), and you have no credit score. Why? If you have no recent payment history (within the last 2 years), then you won’t have a score. Answer: Adding a credit card (even 2 cards) is a great idea! Just know that you won’t generate a score until you’ve made 6 monthly payments.
  2. You’re reducing the amount of total credit available to you (to find out your total credit limit, add the limits of all your credit cards together). If you have balances on other cards, then reducing your total limit will increase your credit utilization ratio. Increasing your utilization ratio is bad for your score (it accounts for roughly 25% of your FICO score) and higher ratios can hurt your score by as much as 120 points. If at any time you’re using over 30% of your total credit limit, your score will drop. And closing a card lowers your total credit limit. For more detail on utilization ratio, see the article: Credit Card Impact: Huge Factor on Credit Scores.

Opening a new card will reduce your average age of open accounts. The length of your credit history (how long it’s been open) affects 15% of your score. Therefore, closing a card will reduce the average age, dropping the score. This can drop scores by as much as 75 points.

Myth 3: Too Much Available Credit Limit Hurts Your Score

Many people think that having a lot of available credit limit hurts their credit score.

After all, we’ve heard the horror stories of people maxing out their credit cards…just because they can. So naturally, some assume that having a lot of available credit is a risk which hurts scores.

While there is some basic logic to this thinking, the truth is that the amount of your “potential” debt (available credit you could spend) is not factored into your score at all.

This wrong thinking is what leads many people to pay off and close a credit card; often one they’ve had for years. If you don’t know why this is bad – go read Myth #2.

Myth 4: Too Many Credit Cards Hurt Your Score

Wrong again. The overall number of open cards doesn’t matter.

However, there are 3 things that do matter for any credit card user:

  • In general, newer accounts will bring down your average length of payment history. That’s why open accounts with longer payment histories help your score. By maintaining a lot of open credit cards with long histories (4+ years), you’ll offset any new accounts that you open. This aspect of your credit can affect your score by up to 15%.
  • If you have lots of credit cards, but not a lot of other account types (i.e., installment or mortgage), your score will suffer a little bit. Having a variety of accounts shows that you can handle paying different types of credit on time. This aspect can account for up to 10% of the score.
  • Having numerous accounts with balances will slightly hurt your score. Some people have a lot of credit cards with unpaid balances. This will drop the score, but only slightly as it only affects less than 5% of the score.

Myth #5: Applying for a Credit Card Will Destroy Your Credit Score

While it’s true that applying for a credit card will cause your score to drop a little, it won’t destroy it. Applying for new credit results in what is called a “hard inquiry” which does cause a small, temporary dip in a credit score. The initial impact might by 5 – 10 points, depending on your overall credit report. But after 4 months, the impact is around 2-3 points. And after 6 months, the inquiry doesn’t affect your score at all! Keep in mind though, that even though credit card inquiries don’t hurt scores after 6 months, they’ll remain on your report for 2 years.

The important thing to remember about applying for credit cards is that each time you apply for a card, it will affect your score. So if you go nuts and apply for 7 credit cards within a short period of time, this could drop the score by 30 – 40 points.

Basically – don’t go nuts.

Just apply for 1 or 2 cards at a time.