The truth about 5 common credit myths
There are many credit score myths out there. Some may be obviously wrong, but others sound so legitimate, it's hard to decide if they're true or not. And if you follow some incorrect credit advice, it could have a negative effect on many aspects of your life, as a good credit score can be the difference in getting a credit card, loan, home or even a job.
So, if you hear a credit score tip, make sure to do your research before you believe it. Two financial advice experts weigh in on some of the common credit misconceptions they've heard, and why they aren't true.
1. You need multiple cards to have good credit.
It's not about how many credit cards you have, but rather how you use them.
"Having multiple credit cards
can definitely help you build a solid
credit history," personal finance blogger Barry Choi, founder of MoneyWeHave.Com, said in an emailed response to questions.
Having a diverse credit portfolio is good, and accounts for about 10
per cent of your credit score.
However, he said, credit
bureaus are more concerned with your debt utilization ratio -- the amount of
available credit you're using --
than how many lines of credit you have open. This ratio accounts for
30 per cent of your overall score, and most experts recommend using
30 per cent or less of your overall available credit.
He offered the following
example: Two people have a credit limit of $5,000. Person A has a $4,000
balance but pays off his full balance before the due date. Person B has a
balance of $1,000, but makes
just the minimum payment. In this scenario, person A is utilizing 80
per cent of his credit while person B has a utilization of 20 per cent.
"As weird as it sounds, person B might have the higher credit score," Choi said.
2. Cancelling your old credit cards will improve your
If the number of cards you have doesn't matter, then you can finally close and cut up that credit card you got 10 years ago that you never use -- right? Though holding onto the card won't hurt you (or help you), closing an old card has the potential to make your score dip a bit.
First, closing any of your cards will affect your overall available credit, and, in turn, your credit utilization ratio, Choi said. The more of your available credit you use -- on an individual card and on all your cards combined -- the worse your score.
Say you have a balance of $700 on your $1,500 limit card, and no balance on your old, $1,000-limit card. Overall, you still are only using $700 of $2,500, putting your credit utilization at 28 percent. . However, if you close your old card, $700 is now almost 50 per cent of your available credit.
Additionally, Choi recommends leaving your oldest card active because it will show a long history of good credit and repayment.
"You don't even need to use that old card anymore if you have another that you're making regular charges to," Choi explained.
That's not to say it's never advisable to close an old card. Just make sure you aren't throwing your utilization ratio off balance when you do, and that you have other cards or products to vouch for your good history.
3. Co-signing on a credit product will not affect my
First, know the difference between being a co-applicant and a guarantor. A guarantor is a spectator -- you agree to take on the loan if the primary borrower can't pay, but you won't be called to action until the lender has exhausted all other means of collection from the original borrower. A co-signer or co-applicant, however, is equally liable for the debt. Once you co-sign a loan for someone, your credit score is on the line.
That means any late or missing payments will affect both you and the primary borrower, says Agnes D'Souza, financial advisor at Scotiabank in Ontario. And if the loan goes into default, it's going to affect both of you.
4. You need to carry a balance to have a good credit
"There's this huge misconception that you need to carry a balance to build a credit history," said Choi.
Credit bureaus don't care whether your card has a balance of $10 or $10,000, as long as you're making at least the minimum payment and it's on time. In fact, paying off your balance each month can be beneficial to you in the long run, as it keeps your credit utilization low and prevents interest charges. And your payment history counts for even more than your utilization ratio, so paying on time is what really matters.
5. Never using your card will improve your credit
Just being approved for a credit card won't help build your credit; you must use the card effectively.
"Lenders want to see that you're using credit responsibly," said Choi. Once you're approved, you need to make regular transactions and pay your bill to build credit. The transactions don't have to be huge or varied. You can set up a recurring charge -- say, a subscription -- to your credit card and pay it off right away.
Getting a card and not using it could actually be harmful in the end, Choi said, because applying for a new card requires a hard inquiry on your score (a soft inquiry, such as an employer background check, won't hurt you). Inquiries count for 10 per cent of your overall score. If you don't use the card to rebuild your history, that hard inquiry won't be repaired.See related: Understanding the basics of credit scores, 6 ways to improve your credit score
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