Exploring common misconceptions about your credit
Tired of the rumour mill when it comes to credit? Whether you’re new to credit, nervous about credit, or even just wanting to level up your financial literacy, you might find credit an overwhelming topic. You know you need it, but how do you get it? You’ve picked up a couple “tips” from people, but not really sure if they hold any merit?
Keep reading to see if you’ve fallen for any of the most common credit misconceptions, or learn from the experts so you never will.
Myth #1: As long as you’ve never missed a payment, your credit score is perfect
“I’ve never missed a payment on my credit card, so my credit score is perfect, right?” Sorry to be the ones to break it to you, but this isn’t true. While making on-time payments is important, there are several other factors at play. Ultimately, making an active effort towards these various factors will help you in building a positive credit score.
- Making on-time payments
- Being aware of your credit utilization
- Differentiating your credit products
- Increasing your credit history length
- Being mindful of credit checks
- Limiting unnecessary debt
Another thing to clarify while debunking this myth is that your credit score doesn’t start at the top of the range, and therefore as long as you’ve always shown good credit behavior, your credit score would be perfect. This isn’t to say that your credit score starts at zero either.
Everyone starts at a “base score,” and this score is different depending on which credit bureau and scoring model are being used. For some, their base score is established when they open their first credit card; for others, it might be when they submit a rental application.
At the end of the day though, there’s no “build credit fast” kind of hack—it takes time.
Myth #2: You only have one credit score
If you’ve checked your credit score on platforms like Credit Karma and Borrowell, you might have already noticed that you have more than one credit score. So, is one more correct than the other, and why do they appear different in the first place?
Let’s start off with the two major credit bureaus: Equifax and TransUnion. Each of these companies calculate your credit score differently depending on the credit scoring model that they’re using. Each of these models put different weight on credit scoring factors, resulting in a different credit score. You can read more about this in our article explaining credit scores.
Side note: Credit bureaus can redevelop their scoring models, which can have an impact on your score, even if your credit behaviours haven’t changed.
While these different methods result in you seeing a different credit score, one isn’t more correct over the other. We empathize with how this can be frustrating, but what’s most important is to be keeping an eye on your score (from whichever platform you choose).
Myth #3: Checking your credit score damages it
We don’t know who started this rumor, but we’re here to lay it to rest. Please check your credit score. When you check your credit score, you’re only conducting soft credit checks, which won’t have an impact. We recommend checking your credit score every month so you can keep your eye on the goal, prevent fraud, and dispute mistakes that could be impacting your credit.
Hard credit checks, on the other hand, do have a small (temporary) impact on your credit score. Maybe this is where the rumor stems from, but who’s to say? When you apply for a new credit account (think credit card, loan, mortgage, etc.), the lender will conduct a hard credit check, which indicates the need and application for credit. These credit checks are a normal part of life and won’t come as a surprise as your consent is required first.
Myth #4: Carrying a balance on your credit card boosts your credit score
There seems to always be someone sharing this piece of advice, but let us spare you. Carrying a balance on your credit card only does one thing: makes you spend more money on interest. If you’re carrying a balance on your credit card (hey, it happens), then technically, yes, paying more than the minimum payment can help build your credit. But you know what builds your credit better and saves you some cash? Paying your balance off in full each month.
We get it. Sometimes paying off your credit card in full each month just doesn’t happen. All we ask is that you don’t carry a balance solely because you think it’ll give your credit a boost. Paying off your balance each month actually demonstrates that you can use credit responsibly and are “living within your means,” which gives lenders more confidence in you as a borrower.
Myth #5: Closing credit cards will improve your credit
Remember a few minutes ago when we talked about how credit scores were calculated? There was something in there called credit history age. This portion of your credit score is determined by looking at your oldest credit accounts, newest credit accounts, and the average age of all your credit accounts. The longer your credit history, the more information that lenders have to assess you as a borrower.
If you have 16 credit cards open, closing a few of those would likely improve your credit because you’d look like a less risky borrower. But if you’re the average Canadian with 1-2 credit cards, then closing your credit card would only negatively impact your credit utilization (how much of your credit you’re using) and reduce your credit history length. Factor in the pros and cons before making a decision to cancel a card: annual fees, benefits, how often you use, and credit limit.
Myth #6: Paying off debt increases your credit score
Many of us have thought this at one point in time. It’s a logical thought, is it not? If you get a car loan, for example, and you pay it off—you’d think that you would be rewarded on your credit score, right? We wish. Truthfully, your credit score will take a dip after you pay off a loan. So, why is that?
Paying off a loan impacts your credit score in a few different ways. Remember that credit utilization, credit mix, and credit history age are factors in your credit score.
Your credit utilization is the percentage of your credit that you’re actively using (to build credit, we recommend keeping this below 30%). Your credit mix is having diversified credit accounts (different types of credit). Your credit history age looks at the length of time your credit accounts are open to determine your experience with credit.
When you close a credit account, the above factors are impacted. You no longer have access to as much credit, which changes your credit utilization. You’ll have less credit products in your report, which impacts your credit mix. Then, your credit history age average is adjusted based on the length of time that account was open.
While your credit score is important, don’t avoid paying off debt for the sake of sparing the credit score dip. Your credit will recover, and having spikes and dips in your credit is completely normal and expected. If you’re looking at a larger investment (like a house), you can choose to be strategic in paying off your debt. However, in that circumstance, we would recommend having a chat with a financial advisor who can take a holistic look at your credit, debt, timelines, and the goal you’re looking to achieve.
Myth #7: Higher pay brings higher scores
Now say it with us, correlation isn’t causation. People that have higher pay may have more opportunities to diversify their credit mix or keep their credit utilization low, but this doesn’t mean that their credit is better. They can still miss payments, live beyond their means, have a high credit utilization, etc.
As you may have noticed in Myth #2, income wasn’t listed in the factors for your credit score. How you choose to educate yourself on credit and use that knowledge to follow best practices will set you up for success more than your paycheque ever will.
Wrap it up
There you have it folks! Hopefully, this information helps to equip you with additional knowledge when it comes to your credit score so you can make more informed financial decisions for your future. If you remember one thing from this article, let it be that your score is going to fluctuate your entire life, and that’s not a bad thing. Do your best to demonstrate good credit build habits, and over time, you’ll reap the benefits.
Legal: This article provides information and is not intended to provide any personalized tax, investment, financial, or legal advice. You are encouraged to seek professional advice before making financial decisions.