5 credit misconceptions
While working at Virginia Credit Union, I’ve learned a lot about finances and how credit works. Even some things that took me by surprise. There are some common misconceptions about credit and the impact it has when borrowing from lenders. Here are a few misconceptions I had before I had experience with credit personally and in my career.
Don’t pull my credit! It’ll lower my score!
Any time you have a lender obtain your full credit history it’s considered a ‘hard pull’ of credit. While it is important to be conscious of the number of hard inquiries on your credit report (a good rule of thumb is no more than four in a 12 month time frame), it is not as much the inquiry that has the impact. The inquiry itself is actually very negligible.
For all consumers, ‘New Credit’ is 10% of our score. When we have hard inquiries, we typically have new credit reported soon after, like a car loan or credit card. You see a drop in your score, and it’s natural to think that is all due to the inquiry. Instead, our scores take a brief dip while we are showing that we can manage our new debt level. This is usually brief and after a few on time payments your score usually bounces right back up!
The thing is, your score usually only impacts you a few times a year. Your monthly budget, on the other hand, impacts you multiple times every single day. If you are considering refinancing your home, car, or debts and are concerned about the hard inquiry, take a moment to weigh how that small inquiry will impact you versus more flexibility in the monthly budget.
I pay all my bills on time, so my credit score should be really high.
While payment history on the credit report is the most heavily weighted individual factor (35% of your score), a close second is the balances we owe versus our credit limits and the initial amount borrowed (30% of your score). You may have great payment history, but if your credit cards are nearing their limit or there’s a lot of new credit changes the score may be lower than you had thought.
For a lot of young borrowers there’s a misconception about what types of bills are going to show up on your report. Payment history on your credit report is for lending debts primarily, therefore utility, phone, rent, and other maintenance payments are not reflected and do not help your credit.
In order for my score to go up, I have to have a balance on my credit card.
Let’s start by defining ‘credit utilization.’ This is the amount you owe on your credit cards versus their limits. The best thing you can do when you have open lines of credit (credit cards, personal lines of credit) is to keep your reported ‘credit utilization’ under 30% -- any time your balance is at or lower than this level you are boosting up your score, while if it’s above 50% it will damage your score.
General rule of thumb here – don’t carry balances unless you have to! If you aren’t paying your credit card off in full every month, you’re paying interest and it’s not necessary. Although the date of the last activity is shown on your credit report and showing recent activity keeps your score up to date, you can demonstrate activity by paying your balance in full monthly. Carrying a balance under 30% utilization will improve your score.
My credit score is high, so I’ll get approved.
Credit scores are just one of the many factors that lenders use to make credit decisions. They are also going to look at your income level compared to your level of current debt, any new credit that’s been opened, and the type of credit you’ve managed previously. If you have a high score, but you also have a high level of debt, you may not qualify for the loan at this time. Similarly, if you’ve had a credit card or two with smaller limits and managed payments, you may have a high score but may not qualify for an auto loan on your own quite yet, as there’s no similar history on the report.
Lenders are also concerned with the type of credit you are applying for, whether secured or unsecured. What’s the difference? When we put something up for collateral, it’s considered ‘secured.’ For example, a mortgage or an auto loan. With ‘unsecured’ debts, the lender releases the funds and trusts you to repay based on credit history and income, but doesn’t hold anything as collateral. These types of debts are things like personal loans and credit cards. The type of credit you are applying for and your history with that credit type will also impact your approval odds.
Medical collections and student loans don’t impact my credit.
Unfortunately, it is far too common for me in my role to see medical collection items on credit reports. These collections do impact your credit score, no way around it. They are designated as ‘medical’ so a lender can choose how this will impact a decision when reviewing the full report, however, there is an impact already to the score.
Student loans, whether or not they are currently deferred, impact you. While in deferment, this debt is still reported to credit. Therefore, lenders are going to take these loans into consideration when looking over your overall level of debt vs. income, which impacts approval odds. When the loan payments become due, it’s important to make sure that you are working with your lender to find a payment that works for you and that you begin paying immediately. One of the most common things that I see that negatively impact young borrowers is concentrated periods of long-standing delinquencies on student loans. This can impact lending decisions for up to 7 years.