Master Debt


The Internet is full of articles debunking credit card myths, usually the same old myths that have been debunked dozens of times before. Fortunately, the most fundamental facts about credit cards have finally become regular public knowledge.

At this point, you probably know that checking your score or shopping for a mortgage within a short period won’t hurt your credit. Some credit myths die hard, though, and new and evolved forms of these modern-day old wives’ tales are born all the time.

Credit Myths Debunked

To be fair — and to make things more confusing — some of these myths can’t be completely debunked, because there is some truth in them. We aim to clear up as much as we can, though. Without further ado, we give you the knowledge to arm yourself against these credit myths.

1. If I don’t use a credit card, I won’t get into debt — Cash is king

There is a simple way for a credit card holder not to get into credit card debt. Just pay off all your charges during the grace period, and you won’t owe a single penny of interest on your credit card. If you can live on a budget with cash, there is no reason why you can’t do the same with plastic.

Granted, not falling into a credit card debt trap does require some discipline, but it’s not rocket science. Don’t spend outside your means. In return for your responsible credit habits you will get a lot of perks: great protection benefits, bonuses and cashback rewards, and an easy and straightforward way to build your credit from an early age. Which brings us to the second myth.

2. You must carry a balance to establish credit

No! This is an outrageous misunderstanding of how credit scoring works.

You don’t have to carry a balance (or pay the resulting interest) to build a great credit history. In fact, it makes no difference in terms of credit scoring whether you carry a balance or pay it in full during the grace period. The conclusion? Pay it off every month.

3. Debit cards also help establish credit

Sorry, they just don’t. Debit cards may look the same, but they simply pull money directly from your bank account. Your debit card history doesn’t indicate whether you can handle credit responsibly or not.

4. Credit cards are a necessity

Look, you will eventually get to build your credit history, just not as early in life as you can with credit cards. The fact is there are plenty of people without credit cards who manage to live a good life. That said, it can be hard to live without credit cards – sometimes very hard (try to rent a car, for example).

So it’s not like you can’t exist without them, but living without credit cards is more complicated, and there is no need to complicate things. Credit cards can’t be “good” or “bad.” A credit card is a tool, and it’s up to us to handle it with care.

5. Opening a new credit card will hurt my score

This myth is a little tougher to debunk because there are hints of truth behind it. When you apply for a credit card, the bank sends one of the three national credit bureaus what’s called a hard inquiry to check your credit. It may ding your credit score by 2-5 points or slightly more. The amount of damage depends on the length of your credit history and other factors.

Interestingly, however, some people may find themselves in a better position after getting a new credit card. Here is why: Even though you might lose 2-5 points by applying for a card, there is another, more important, factor to your credit score than a hard inquiry. It’s called credit utilization ratio or utilization rate.

Simply put, utilization ratio is the ratio of your debt to your credit line. The lower it is, the better. So what happens when you receive a new credit card? You also get a new credit line. As a result, you may see your utilization ratio go down, which positively reflects on your FICO score. Most credit experts recommend to keep it under 30, or even 20 percent.

6. A higher income means a higher FICO score

You have all the reason to be proud of yourself, but credit scoring is a great equalizer. It doesn’t care how much money you make. FICO’s only concern is how well you can manage credit and debt. Your income and business acumen don’t tell a potential creditor whether you are a credit risk or not.

7. As long as I pay my credit card bill on time, my score can’t go down

It might sound logical, but this is not the way the system works. If your utilization ratio gets out of hand, your FICO score will go down regardless of your payment history.

Let’s say you have three credit cards with the total line of $10,000 and that you utilize about $2,000 of your available credit each month. Your ratio is 1/5 ($2,000/$10,000), or 20 percent. But what if you decide to cancel one of your cards with a $5,000 line of credit?

Your spending habits haven’t changed, so you still charge $2,000 a month. Plus, you still pay your bills like clockwork. Your credit line, however, has been reduced to $5,000, so your utilization ratio has doubled to 40 percent. When this happens, it’s very likely that your FICO score could drop despite your excellent payment history.

Hence the strategy — keep your debt low and your credit line high. And that brings us to the next mysterious myth.

8. Credit line increases are offered to entrap you

The increase on your credit line also means your bank believes you’re trustworthy. Your credit card issuer will not offer a credit line increase to someone it considers a credit risk. Your move? Take advantage of the increased credit line without falling into a trap — just leave it be and don’t fall into the temptation of taking on new debt, which would adversely affect your utilization ratio (see #5).

9. If I don’t use a credit card account, I should close it

That’s another myth that seems like sound financial advice, especially for OCD folks that want everything as simple and organized as possible. But it can actually hurt your credit score rather than help it. Closing a credit card affects two FICO score ranking factors — utilization ratio — because you’re overall credit line will be less — and the average age of accounts (AAoA). While AAoA is not a major factor and has a delayed effect (your balances will keep being reported for the next 7years after the closure), it still matters (see myth #7).

How many credit cards are too much? Everyone’s credit profile is different, so there is no universal answer. If you don’t need a credit card that carries an annual fee that may be a good reason to close it. If you’re simply annoyed that it takes up space in your wallet, though, just put the card in a sock and put the sock in a drawer.

10. I have good income, so I can afford credit card debt

Though it might be true that you can afford it, the question is — why would you want to? The opposite would sound more logical — those who are living paycheck to paycheck may have to borrow from a credit card to make ends meet. Having a good income, on the other hand, is hardly a reason or an excuse to carry an unnecessary credit card balance.

Now you should have a better understanding of some of the most outrageous myth-inspiring credit card presumptions. Overall, there are no reasons to be scared of a credit card. It’s a great tool to establish a credit history. It has free protection benefits, gives you a chance to earn bonuses and cashback, and is convenient. Just treat your credit card like you would treat cash — know your limits and don’t go over your budget. Pay off your balances every month, and you will be just fine.

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