Credit and the credit myths surrounding it have become as American as baseball and apple pie. It’s part of what we do and how we do it. Each household carries an average of six credit cards and spends more on credit cards than most other nations.
We don’t lead in debt per-capita. But that stat is driven more by housing costs than by credit cards.
Credit is a powerful tool. Powerful tools can be dangerous if not used properly. Understanding credit is key to using credit wisely. Here are six of the most common credit myths and the real truths about them.
1. The “One Score” Myth
A common myth is that you have one credit score. This is untrue.
A credit score is a number that a scoring company determines using an algorithm designed to gauge your likeliness of paying back your debts. There are many types of debt, and scoring companies build models specifically for each major type of debt. For example, a consumer’s likelihood of paying back their mortgage may be slightly different than paying back their auto loan, which may be slightly different than paying back their credit cards.
There are different scoring models for different types of debt, and variations between scoring companies.
Additionally, your credit reports from the three major credit bureaus are probably not identical. The same algorithm would produce different scores with different input. And your credit bureau information changes continuously as you make payments, etc.
Your scores should be similar. But there’s the possibility of large variations when credit bureaus have different information. Differences of 25 points or so are normal, but differences of 100 points or so are possible in some cases.
You have a number of credit scores, which should tend to be clustered closely together.
2. The “Plunging Score” Myth
The “plunging score” myth says that applying for credit will ruin your score. Not exactly true.
An inquiry for the purpose of granting credit will make a small difference in your score. A lot of inquiries will make a bigger difference — but not always.
Credit bureaus expect you to shop for credit when you are considering credit for the purchase of a home, the purchase or lease of a car, or when taking out school loans. Inquiries for these purposes are considered as a single inquiry for scoring purposes when the inquiries occur very close together. What very close together means, however, can vary a little.
Different algorithms will treat multiple inquiries as one in different situations. Some algorithms allow up to 45 days, but that’s not the norm. You should expect for mortgages, auto loans, and school loans to have at least 15 days to shop for the best deals. Any inquiries for these purposes should be treated as a single inquiry if the inquiries are within a 15 day period for the same purpose.
A mortgage and auto inquiry would still be two inquiries, but eight auto inquiries made in one week would be scored as a single inquiry.
To have great credit, you should keep your inquiries low. But don’t worry about shopping around for a car loan trashing your credit — just do all your searching at once.
3. The “No Debt Makes Perfect Credit” Myth
The “no debt makes for perfect” credit myth says that if you don’t have any debt you’ll have great credit. This is very wrong.
You need to use credit in order to have a good credit score. The largest single factor in determining your credit scores is payment history. If you never have debt, you’ll never have a payment history, and you’ll never have good credit.
This doesn’t mean you have to rack up debt. You can build a great score without ever really having significant debt. But you need to at least charge something and pay it off to have a history of making payments.
You cannot build credit without using credit.
Related to this is that one time isn’t sufficient. Taking out an auto loan and paying it off the first month isn’t going to do much for your credit. Taking out an auto loan and making the scheduled payments on-time every time will build credit.
4. The “If You Have a Judgment or Bankruptcy You’ll Never Have Credit” Myth
Bankruptcies and judgments are bad for your credit. But the damage is neither irreparable nor permanent.
The recency of a major negative like a bankruptcy or judgment matters. Something that happened four years ago is less damaging than something more recent. But you need to help yourself as well.
Bad things happen. People end up with bankruptcies and judgments. It doesn’t mean that they are bad people. But it does indicate they have had, for some reason, a problem with credit.
If you have had such a problem, you should begin rebuilding immediately. Remember you build a good score by using credit responsibly. There’s no other way. Eventually, the negative item will fall off of your report. You don’t need to wait for that to happen. What happened more recently is important.
If you have a judgment or bankruptcy, begin building a positive history right away. You may need to use a secured card or a card for people with bad credit. Immediately establishing a positive post-bankruptcy history will help you move forward.
Do that for a year or more and you should be able to get a car loan — and keep building from there.
5. The “I Got Bad Credit From My Spouse” Myth
Your credit score is based upon your history with credit. You have your history, others have theirs. The only credit items that can impact both your score and your spouse’s are things you signed for jointly. Their individual use of credit does not impact your score; nor does your use impact theirs. This is true in any relationship, marriage or otherwise.
If you have good credit, getting married won’t damage your score. If you have bad credit, getting married won’t improve your score.
The problem with marrying someone with bad credit is that it may be harder to jointly qualify for a mortgage or other large purchase.
It’s always a good idea to be careful using your good credit to help someone with poor credit. It took you time to build good credit and it took them time to get poor credit. A spouse with bad credit isn’t the end of the world. They can build credit; you just may have to plan carefully until they do.
6. The “You Don’t Need Credit” Myth
There are advocates of never using credit and never having to worry about a credit score. But there are significant downsides to that approach.
Purchasing a home or other real estate is nearly impossible for the average person without credit. Actually nearly impossible except for those born into big money. In many areas, home prices increase faster than you can save and keep up.
It’s hard to pay high rent and build funds to pay for a half or three-quarter-million dollar house in cash at the same time. It may be possible, but that doesn’t make it a great idea.
It’s also difficult to rent a car without a major credit card. Some rental companies will allow you to rent a car with a debit card, but there are often restrictions. And most won’t take single-use prepaid cards, either.
There’s not a consistently good way to rent cars without a credit card.
Most people engage in online transactions, which can be done with either a credit or a debit card. With a credit card, you have specific legal protections. With a debit card, your legal protections are generally limited, with some variation between issuers.
Many people make significant purchases only with credit cards for that reason. It’s not really an issue with $30 of gas or $50 of groceries, but it’s definitely an issue with larger purchases or when you don’t know the seller.
Poor or no credit can cost you in other ways. In some states, the cost of auto insurance is dependent on your creditworthiness. People with poor or no credit pay more for their insurance in those states.
You can get by without credit. You may not want to, and in many cases, it may hurt you more financially than it will help you.
Final Thoughts on the Myths About Credit
The use of credit allows people to accomplish things financially they couldn’t otherwise. Most people would never own a home — and certainly not their dream home — without credit. Most people would be limited to buying and driving used cars. And leasing cars would be out of the question. Credit allows us to travel with ease that wouldn’t be possible without credit. But we need to use credit wisely.
Abuse of credit gets people into trouble they could likely have avoided. People tend to think they’ll be able to handle payments they can’t. Some people mistake wants for needs. There’s no reason to see exactly how much you can afford to buy on credit. It’s far better to err on the side of caution, many people would benefit from using less credit.
As with most financial matters, knowledge is a necessary condition for achieving effectiveness. Understanding credit can help you use credit to build and achieve things you couldn’t without credit — and likewise help you avoid the trap of using credit for things you can’t afford.
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