Despite the Consumer Financial Protection Bureaus efforts to make the credit industry easier for consumers to understand, credit cards have spawned more myths than The Iliad. Though recent pieces of legislation like the CARD Act have made paying with plastic safer for consumers, theyve done little to dispel many of the half-truths and untruths that many Americans continue to believe regarding their cards.
Right now, the average household is saddled with more than $10,000 in credit card debt, and you have to believe that at least some of that comes from a failure to understand how credit really works. That’s why weve decided to put on our Mythbusters costumes and shed some light on the four most common misconceptions consumers tend to have about their credit cards. So get out your pens and paper, class, because were about to hit you with some knowledge.
1) Debit cards contribute to your credit score. Although debit cards look, smell, feel and probably even taste just like credit cards, theyre fundamentally different products. Credit card transactions are kind of like short-term loans. Your issuing bank credits you for a purchase, and you agree that youll pay them back at the end of the month. Your small-loan repayment history is what lenders look at to determine how worthy you are of obtaining a larger loan.
Debit cards, on the other hand, pull money directly from your checking account. Since youre spending your own money instead of borrowing it, theres no need for your purchases to be monitored. Therefore, your debit purchases have absolutely no effect on your credit score. This is especially true for prepaid debit cards, which like to pretend that they can build your score when they really cant.
2) Checking your credit can hurt your credit score. Another common misconception about credit scores is that monitoring services like Equifax will ding your score every time you check it. While its true that hard inquiries (like the kind that card issuers use to look you up every time you file an application) will drop your score by a little, checking your score yourself wont do any damage whatsoever.
Under federal law, every American citizen is entitled to one free credit check every year. These soft inquiries will appear on your personal credit statement, but theyll be invisible to lenders and credit card companies.
3) Carrying a balance is a good way to increase your creditworthiness. Many people believe that carrying a small balance on their cards every month will work as some sort of tribute to get themselves in the good graces of their card issuer. We dont know who came up with this hare-brained scheme, but we certainly wish people would stop falling for it.
The only thing youll get by carrying a regular balance on your card is a bunch of interest charges. It wont hurt your credit score, but it isnt doing you any favors either. Its far better to pay your balance off in full each month. Your credit rating might not change, but youll be much better off financially.
4) Its totally cool to max out your credit card if you dont go over the limit. Your rewards credit card might carry a $10,000 spending limit, but that doesnt mean its a good idea to spend $10,000 with it. Maxing out your card screws up your credit utilization ratio, which is one of the big things FICO looks at when determining your credit score. Consequently, a maxed out card will demolish your credit rating. On top of that, that huge balance accrues a ton of interest.
Put bluntly, you should never max out a credit card under any circumstances. At most, your balance should be capped at 30% of your available limit. This will help you maintain the most favorable utilization ratio for your FICO scores, and it will also prevent you from spending yourself into extreme debt.
Credit cards arent the most difficult things in the world to understand, but it doesnt take much for a little misconception to seriously impact both your credit score and your personal finances. Always make sure to read your card agreements carefully so that you understand all the terms and conditions associated with your various pieces of plastic, and never be afraid to ask experts like us for help. Remember, when it comes to your line of credit, its always better to err on the side of caution.