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Three Credit Score Myths That Are Wildly Untrue

Sydney Enzler opened her first credit card when she was a 19-year-old college student. Her mom encouraged her to open the account in order to build credit and establish a strong credit score.

“I wanted to use my credit cards every once in a while to build credit, but I generally just use them for larger purchases,” said Enzler.

Now 24 years old, Enzler is one of the millions of Americans who owe a collective $1.1 trillion dollars in credit card and other revolving debt. According to the Federal Reserve, the average interest rate on those credit card balances is 16.97% APR.

With interest rates that high, it’s easy to see how credit card debt can quickly spiral out of control and leave you with a bruised wallet – and ego. The reality is that credit cards aren’t going anywhere, and they play a large role in determining your credit score – a critical factor when it comes to getting the lowest possible interest rate on your mortgage or other loans.

Today, I am dispelling three common credit card myths so that you can focus on the things that will actually improve your credit score.

Myth 1: Carrying A Small Credit Card Balance Is Good For Your Credit

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I applied for my first credit card shortly after my 18th birthday and I remember being told by a well-meaning colleague at work that I should try to use the card regularly and carry a small balance. The rationale was that by using the card and paying a small amount of interest monthly, the bank would love having me as a customer and give me a better credit score.

Fortunately, I was a curious teenager and fact-checked that claim, because it’s not true. And not following that advice has saved me hundreds, if not thousands of dollars in unnecessary interest charges over the years.

To begin, your credit score is not determined by your credit card company or any other lender. Your credit card issuer (in my case it was Chase), provides the credit bureaus with regular updates on your payment and account history. These credit bureaus (Equifax, Experian and TransUnion) simply receive information from your lenders and use it to calculate your credit score.

Second, carrying a balance on a credit card will increase your utilization, which could actually lower your score. In general, using less of your available credit is better from a credit score perspective.

The important lesson here is that it’s never wise to pay interest on your credit card if you can avoid it. Always pay off your full statement balance in full if possible. It will help you lower your credit utilization while avoiding costly interest charges.

(Read: The 60 Second Guide To Credit Utilization.)

Myth 2: Checking Your Credit Report Will Hurt Your Score

Reviewing your credit score regularly (and for free) is one of the best things you can do as a responsible credit card user. Period.

However, the myth that checking your credit hurts your score pervades, in part, because of the confusing language that’s used to notate when your credit file has been accessed. Whenever your credit report is requested, you’ll receive an ‘inquiry’. However, it’s important to note that there’s a big distinction between ‘soft’ and ‘hard’ inquiries.

When you request your own credit report, this qualifies as a soft inquiry. Soft inquiries have no effect on your credit score whatsoever. That means that checking your own credit report will not hurt your credit score. It’s that simple.

However, when you apply for a new loan or other type of credit, the prospective creditor will access your credit file to assess your creditworthiness. This will result in a hard inquiry, which will, in fact, have a negative impact on your credit score. Hard inquiries will remain on your credit file for two years, although they will only affect your score for 12 months.

If you’d like to check your credit report, you can do it here for free. By law, each of the three major credit bureaus must give you free access to your credit report once per year. I try to check a credit report from a different bureau every three to four months to check for inaccuracies or fraud. In fact, I just requested my credit report while writing this article and it took all of 90 seconds. You should do the same.

Bonus: If you are serious about protecting your credit you should also freeze your credit files for free.

Myth 3: You Can Pay Someone To Fix Your Credit Score

If you have a history of making late payments and don’t practice sound credit management, there’s no magic switch you can flip in order to have accurate information removed from your credit report on-demand.

While there are a lot of credit repair services roaming the web and social media, the fact is that they don’t do anything that you can’t do on your own.

The best way to repair your credit is to practice good credit management strategies. This means paying your cards and other credit accounts on time, every time. It also means understanding how credit scores work and what the components that go into your score are.

The components of your credit score are as follows:

  • Your payment history comprises 35% of your credit score
  • Amount of debt (credit utilization) comprises 30%
  • Length of credit history comprises 15%
  • Amount of new credit (and inquiries) comprises 10%
  • Your credit mix comprises the final 10% of your credit score

This means that 50% of your score (payment history and length of credit history) is related to time. Clearly, to meaningfully improve your score it will take patience.

If you’re getting ready to apply for a mortgage, or if you are hoping to lower your student loan interest rates by refinancing, here’s what you can do to give your score a boost more quickly. Thirty percent of your score is based on your credit utilization, which is essentially based on a current snapshot of your accounts. While it could take years for negative marks to roll off of your credit report, you can quickly lower your credit utilization.

Your credit utilization is determined by taking your outstanding balance on your revolving credit accounts and dividing it by the total credit available to you. It could take several weeks for the updated information to be passed from your creditor to the credit bureaus, but it’s a fast way to improve an important metric. For the highest credit scores, aim to lower your utilization below 10%.

Don’t lose sight of the fact that it can take time to improve your credit score. Start to establish healthy credit habits today so that your score reflects them in the future. But most importantly, don’t despair if your credit isn’t perfect.

Regardless of what your credit score is, it’s important to know that your credit score might not be as important as you think it is.

Follow me on Twitter or LinkedIn. Check out my website or some of my other work here.

Camilo Maldonado is Co-Founder of The Finance Twins, a personal finance site showing you how to budgetinvestbanksave & refinance your student loans. He also runs Contacts Compare.

Source: Three Credit Score Myths That Are Wildly Untrue

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Everything I’ve Learned About Personal Finance in 10 Sentences

We’ve featured a lot of tips from The Simple Dollar’s Trent Hamm—from buying in bulkand earning money online to managing a career hiatusand overcoming decision fatigue. Here, he shares his ten most important pieces of financial advice……..

Source: Everything I’ve Learned About Personal Finance in 10 Sentences

Financial Advice For Young People Isn’t Always Right – Erik Carter

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One of the things I most often hear from people about personal finance is how much they wish they had learned about it when they were younger. In talking to younger people, I do see a lot of awareness about the importance of financial wellness. Unfortunately, there are also a lot of myths and generalities circulating around about how young people should manage their money. Here are three of the most common:

1) Focus on paying off your student loans early.

I get it. No one likes paying student loans and we’d all like the day to come as soon as possible when we no longer have to make those payments. However, student loans typically have relatively low interest rates (at least for undergrads) so any extra cash you have would probably be better off used to pay down higher interest debt like credit cards or invested for a greater expected rate of return (especially if you can get matching contributions in your employer’s retirement plan).

A good rule of thumb I suggest is to pay down debts early if the interest rate is above 6% since you may not earn as much by investing extra savings instead. If the interest rate is below 4%, you should probably just make the minimum payments since you can likely earn more by investing the extra money. If it’s between 4-6%, you can go either way depending on how comfortable you feel with debt vs. your risk tolerance with investing. (The more conservative you are, the more it makes sense to pay down debt vs investing.)

So, what should you do with your student loans? First, see if you can refinance your debt to get a lower interest rate. (Just be careful about switching from government to private loans since you lose a number of benefits.) If the rate is low, you might even want to switch to an extended payment plan since the lower payments will free up savings you can use for other goals like saving for emergencies, buying a home or retirement. If the rate is high, try to pay it down early after building up an emergency fund, getting the full match in your retirement plan and paying down any higher interest debt.

2) Roth accounts are better for young people.

Unlike traditional pre-tax accounts, Roth accounts don’t give you any tax break now, but the earnings can grow to be withdrawn tax-free after age 59 ½ as long as you have the account at least 5 years. The argument here is that young people have more time to grow those tax-free earnings. They’re also early in their careers so they may be in a higher tax bracket in retirement.

However, if you’re trying to save for emergencies or a home purchase and are just contributing to your retirement plan to get the match, you may want to make pre-tax contributions and use the tax savings for your other goals. Even if you’re focused on retirement rather than more immediate goals, a traditional pre-tax account may still be better for you if you’ll end up paying a lower tax rate in retirement.

If you plan to go back to school full-time, you can also convert those pre-tax dollars to Roth at a time when you’re in a fairly low tax bracket. If you’re not sure which makes sense, you can split your contributions between pre-tax and Roth or contribute to your employer’s plan pre-tax (it may even be the only option) and to a Roth IRA (which has additional benefits).

3)  Invest aggressively while you’re young.

There is some truth in this. The longer your time frame, the more aggressively you can generally afford to invest your money and young people tend to have long time horizons before retirement. There are a couple of important caveats here though.

The first is that not all of your money has a long time frame. For example, financial planners generally recommend that one of your first goals should be to accumulate enough emergency savings to cover at least 3-6 months of necessary expenses. This is especially important for young people who are more likely to change jobs and haven’t had as much time to accumulate other assets like home equity or retirement plan balances to tap into.

You may have other short term goals to save for like a vacation or home purchase. Any money you may need in the next 5 years should be someplace safe like a savings account or money market fund since you won’t have much time to recover from a downturn in the market.

Speaking of downturns, the second problem is that this advice ignores risk tolerance. Many young people are new to investing and may panic and sell at the next significant market decline. If this sounds like you, consider a more conservative portfolio (but not TOO conservative). If you have access to target date funds, you may want to pick a fund with a year earlier than your planned retirement date. You can also see if your retirement plan or investment firm offers free online tools to help you design a portfolio customized to your personal risk tolerance.

Of course, there are plenty of young people who should pay down their student loans early, contribute to Roth accounts and invest aggressively. The key is to figure out what makes the most sense for your situation. If you want help, see if your employer offers free access to unbiased financial planners as an employee benefit or consider hiring an advisor who charges a flat fee for advice rather than someone who sells investments for a commission or requires a high asset minimum that you may not be able to  meet. In any case, you don’t want to make the wrong choice now, and regret it when you’re older.

 

 

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