Credit scores are confusing. You can pay off your student loans and see your credit score drop. You can add significant credit card debt and see your score soar. It's no wonder there are so many misconceptions about how to build or improve credit.
Many of these credit myths are accepted as truth by a significant portion of Americans – maybe even you. And they can be costly. Here are three that are especially damaging:
Myth No. 1: "Carrying a credit card balance will improve your credit score." Carrying a small balance on a credit card from month to month costs you money, and it probably doesn't affect your credit at all. But a new NerdWallet survey found that more than 2 in 5 Americans think that carrying a small balance from month to month can help improve a person's credit scores, while 1 in 5 think it can hurt it.
This myth probably has its roots in the fact that using credit is indeed better for your credit score than not using credit. But many people misunderstand what this means. Credit card issuers report your balance to the credit bureaus once a month, but they don't necessarily do so right after your due date. As long as you're regularly using your credit card for something – utilities, everyday expenses, et cetera – you'll get the benefit.
Carrying a balance on a credit card from month to month instead of paying it off doesn't do anything but cost you money in interest.
Myth No. 2: "Your credit only matters if you need to borrow money." The importance of good credit isn't limited to your ability to get a credit card, mortgage or other loan. Your credit history can affect which apartments you can rent or what kind of cell phone service you can get. It can influence the cost of car insurance and utility deposits. Your credit can even determine whether you get a job you've applied for.
According to NerdWallet's survey, almost one-quarter of Americans don't know that having bad credit can negatively impact a person's ability to rent an apartment, and about half don't know that bad credit can limit their options for cell phone service. People with bad credit often have to settle for subpar options or pay outsize deposits.
Plus, almost half of Americans don't know that having bad credit can increase the cost of car insurance, and 52 percent don't know that bad credit can raise the cost of utility deposits
Landlords, utility companies, insurers and others check your credit for signs of whether you can be trusted to pay on time and whether you can manage your debt load. Your credit report isn't the only indicator of your financial habits and behavior, but it's one of the easiest ways to examine them. You can access your free credit report once per year from each of the three credit-reporting bureaus – Equifax, Experian and TransUnion – at annualcreditreport.com.
Myth No. 3: "You start out with a perfect credit score." More than 1 in 10 Americans think that everyone starts out with a perfect credit score, and then their actions determine where it goes from there. In reality, you build credit from scratch. You don't start out at zero, but you do have to work your way up to an excellent score, so it's wise to start building credit before you need to use it.
So how do you get an excellent score? The five factors that typically make up a credit score are payment history, credit utilization--how much credit people are using versus how much credit people have access to--length of credit history, types of credit in use and new credit. When trying to build or improve your score, focus your attention on the first two since they tend to have the largest effect on your score.
Pay every bill on time, 100 percent of the time. If you have to be late, pay within 30 days, so it isn't reported to the credit bureaus. And prioritize paying down your consumer debt. By focusing on these things, you can work your way up to a great score.