Credit scores and reports are complex and can be confusing. When you are young and beginning to build your score, hearing contradictory information can be overwhelming. As a loan officer I often have adults coming into my office with information they have already heard – some of it fact and some of it fiction. I would like to clear up a couple of these credit score myths.
1. Maxing out
A common thing I hear is, “I was told to get a small-limit credit card, spend my limit, and then pay the minimum balance until the card is paid off.” When using a credit card, no more than 30% of the limit should be used – no matter what the limit is. If the balance is at 30% or more of the credit limit, the credit score will begin to decline. The reason? It reflects positively if you have funds available for use but you don’t need to use them all. It is best to pay your statement balance in full each month. Fulling paying the balance will help prevent interest from adding up. It also shows that the credit offered is not being used as an extension of your income.
2. Prioritizing payments
Myth number two: “I have a few collections, and I am going to start making payments on the oldest one first.” It may take up to seven years for debt collections to fall off the credit report, which is required by The Fair Credit Reporting Act. This doesn’t mean that one should wait the seven years for those to “disappear,” it just means to prioritize the most recent collections before the older ones. Although the debt falls off the credit report after seven years, that does not mean that the debt doesn’t exist any longer. This debt is still owed, it just stops reporting to the credit bureaus.
3. Closing your cards
Another common statement: “I am going to pay off all of my credit card debt and close all of my cards.” While it is great to pay off credit card debt, my recommendation would be to pay it off and keep some cards open. If a card is not being used for an extended period of time, some companies may close the account for you. If you pay off a card and close it, the positive payment history that was reporting to that card is essentially gone: It is taken out of consideration for your score completely. I am not saying to never close a credit card, I would just recommend keeping at least one open to report for revolving credit history. The other reason is to show you have available credit, and having a balance not used helps the capacity. (The capacity is the percentage mentioned earlier, which should be under 30%.)
4. Paying in cash?
One more bit of information I hear is, “My credit should be perfect; I have paid for everything in cash.” Saving up for things and paying for them in cash is an incredible feeling and saves money spent on interest. Just be sure to finance something occasionally. If the credit report doesn’t stay active, the score will not only go down but go away after some time.
There are so many components that go into an individual’s credit report, and I have only gone over a few of them. Credit is something that is important to start building as soon someone’s 18th birthday comes up, if not sooner. A good credit score comes with time and experience, so it takes patience. When it comes time to buy a vehicle and the interest rate is low, or time to purchase a home and the mortgage is pre-approved, it will be well worth it.
Meranda L. Scheel is a financial services specialist in the downtown Menomonie office of Westconsin Credit Union, a community partner of Chippewa Valley Family.