Just this past weekend, my cousin informed me how great his credit is because he takes such wonderful care of it. Upon further discussion, I discover his credit score is 654 (most Canadians are in the respectable 700 range), and all his actions to protect his credit thus far have been, shall we say, uneducated. It’s not the first time I’ve heard stories of people engaging in odd practises because they’ve heard it’s good for their credit rating.
Over the years, banks have been very secretive about credit information and what detracts or improves a person’s credit. The simple fact is, unless your banker has made it their mission to understand credit, they may not even know the ins and outs of the system. This perpetuates further misguided notions for protecting and maintaining a good credit standing. Allow me to enlighten you with a few common credit misconceptions.
- Lowering your credit card limits improves creditworthiness. This is probably the most commonly practiced effort to improve credit. The theory is a high limit will prompt a lender to think you might go out tomorrow and shop till you drop, maxing out your available credit. Therefore, to gleam good results many consumers call up their creditors and ask for a limit reduction. Not a good idea at all. Utilization is the outstanding balance compared to the available limit. Healthy credit utilization is 25% or less. Credit scores look at individual utilization ratios as well as overall utilization. On a $4000 limit, 25% utilization is $1000. If you reduce that limit to $2000, your utilization ratio jumps to 50%. A balance of less than 25% of available credit indicates you manage spending and credit use well. It also contributes to 30% of your credit score. Therefore, lowering your credit card limits actually hurts your credit score.
- Every inquiry lowers a credit score. Nope, not true at all. Many people avoid any kind of inquiry for fear of irreparable damage to the coveted score. That’s overdoing it to say the least. First of all, there are different ranges of inquiries, soft and hard. A soft inquiry is non-evasive, such as a consumer looking at his or her own credit report. Since there is no credit application attached to the inquiry, there is no change to the credit score. Secondly, credit reports accommodate rate shopping. That means you can apply for an identical loan at several financial institutions within 30 days, and you will only be scored for one credit check. By the way, time is a big healer when it comes to all things credit. The more time that passes after a hard credit check, the higher your score will be, and inquiries only stay on your report for two years.
- More credit cards mean better credit. Having too many credit cards is not the best answer for stable credit. While your credit score does consider the amount of active trade lines (credit accounts), it looks for a variety of credit usage. Car loans, rrsp loans and mortgages in the mix identify a consumer with strong credit management skills, whereas a history that is largely overpowered with credit cards will suffer a lower score.
- I never use my credit cards. Avoiding all credit usage certainly won’t help you. Credit scores rely on recent activity to articulate your ability to handle credit. Cards that never get used won’t even make it to the calculation, since there needs to be at least 6 months of activity to be reviewed. Never using your credit card means you won’t establish payment records (35% of score), you won’t establish utilization ratios (30% of score), you won’t assist length of credit in use (15% of score) and you won’t contribute to types of credit in use (10% of score). Credit scores calculate your risk based on credit use, so if you have an old card collecting dust in your wallet, call the phone number on the back. There’s a good chance that unused card has been cancelled anyway.
- Closed accounts improve your credit score. I’d really like to know who started this rumour. Granted, an account closed by the creditor due to delinquency will hurt your score, but by that point, you`re already in trouble anyway. While too many accounts aren’t great for your score, once you’ve opened it, you’ve already made that bed. Again, credit scores look at utilization, the amount you owe versus your available credit. Closing an account only lowers your available credit making it tougher to keep the desired 25% utilization ratio. There’s also payment history and length of trade lines that diminish from account closures.
If you have read this and discovered you’ve fallen prey to one or more of these misguided credit notions, don’t despair. Time heals all wounds, so from this point forward you are armed with information that really will help your credit score ambitions. While a large part of credit scores require you to “use it or lose it”, it`s how you use your credit that determines your skill with credit.