The Truth About Consumer Credit
There’s a lot of misinformation out there about consumer credit. Many commonly accepted notions are simply wrong. Here’s what will build rock-solid credit and what won’t.
What counts most
The most important thing for building creditworthiness and achieving a good credit score is to pay credit card balances and installment payments on time, every time. Installment payments are things like car loans and mortgages. Banks, mortgage companies and other dispensers of credit look at your payment history more than any other detail.
How much of your available credit you are using is the second-factor creditors look at in deciding whether to loan you money. It’s worrisome to creditors If you bump against your credit cap often. But using a manageable amount of your available credit is good.
Creditors also look at the length of your credit history and the types of credit you have.
How do I build consumer credit?
If you have not established a consumer credit history, creditors consider your record to be “thin.” Taking on a credit card will help you establish a good credit history, provided you pay the entire balance owed each month. You must be very disciplined about not charging more than you can pay off in full. Paying the minimum payment due puts you in danger of racking up a runaway balance, plus you’ll pay exorbitant interest.
Once you have some positive payment history behind you, car loans and even a mortgage become easier to acquire.
Common credit myths
Student loan debt doesn’t affect your credit score. False. Student loan debt can damage your credit score, so make your loan payments on time every month. If you have trouble remembering, set up an auto-draft payment plan.
Carrying a small credit card balance helps your credit score. Not true. There is no upside to failing to pay off credit card balances in full each month. Those balances carry a 19 to 21 percent annual interest rate, and as the debt accumulates, the risk increases that the balance will grow too large for you ever to pay off.
A higher income improves your credit score. Not by itself. Your credit score is primarily based on making timely payments and how much of your available credit you use. If you update your rising income with your credit card companies, they may increase your available credit limit, and depending on how much of that you use, your score may improve.
Paying off debt improves your credit score. It depends. Paying off credit card balances certainly will. Paying off your mortgage or car loan? Not so much. But lowering your total indebtedness is always a good thing.
Checking your credit score hurts your rating. Not if you do it yourself. That’s called a “soft check,” and you should perform one annually. A “hard check” is when a potential creditor checks your report. Hard checks tell the credit rating bureaus that you are looking to acquire more debt, and they can slightly ding your score.
Spouses share a credit profile. Untrue. You each have individual profiles and scores.
Closing credit card accounts help your score. Incorrect. But having credit cards that you seldom use can help your score. Of course, if a particular credit card has a high annual fee, asking the company to switch you to a card with a lower one may make sense.
Negative credit issues stay on your credit report forever. Fortunately, no. But poor payment history and defaults stay for seven years. Bankruptcies stay for ten.
You can pay to have your credit “fixed.” Anyone claiming they can “fix” a bad payment history is a scammer. Checking your credit annually can help you catch genuine mistakes in your history. But the only way to repair a bad record is time and faithfully paying your obligations when they’re due.