Campaign Against Financial Myths: Part 5 - Credit Cards & Credit Score

(This article is a part of the series aimed at dispelling some of the popular financial myths. Please refer to the full index for myths related to other financial topics. Oh, and a quick disclaimer: I am not a financial advisor. I have made every effort to research the facts before presenting them here. But, if you have a reason to believe any of the statements are incorrect, please feel free to correct me.)

1. Myth: “I need to carry a balance on my credit card to build credit history”

If I received a dime for every time I heard this, I would likely be a rich person by now! A lot of people believe in this myth and make the credit card companies rich. You do not have to carry a balance and fork over money in the form of interest to build your credit history. As long as you own a credit card, even if you pay your balance in full each month, you will still build credit history.


2. Myth: “I will be liable for all the charges if someone steals my card and runs up a huge bill”

Almost all credit cards today come with theft liability protection. If you report the loss before your credit cards are used, the Fair Credit Billing Act (FCBA) says the card issuer cannot hold you responsible for any unauthorized charges. If a thief uses your cards before you report them missing, the most you will owe for unauthorized charges is $50 per card. Also, if the loss involves your credit card number, but not the card itself, you have no liability for unauthorized use. You can find more information about this here.


3. Myth: “Checking my credit report will reduce my credit score.”

When you check your own credit report it is termed as “soft pull”. When other companies pull your credit report, for instance when you apply for a loan or new credit card, then it is termed as “hard pull”. Soft pulls do not result in reduction of credit score. In order to protect yourself against identity theft it is recommended that you check your credit report periodically. By law, each of the three credit reporting agencies are required you to let you check your credit report for free once per year. You can order your free report by going to annualcreditreport.com or by calling 1-877-322-8228.


4. Myth: “I should cancel some of my cards since I have too many.”

According to this article on the myFICO.com website, 15% of the credit score is based on the length of credit history. By closing down some of your older credit cards, you could reduce the average length of your credit history and hence reduce your credit score! In addition, 30% of your credit score is dependent on the amount owed. One of the ways this is quantized is to consider the proportion of balance owed to the total credit line. By closing one (or more) of your accounts, you will reduce the total credit line. If you have any debt on your credit cards, this will result in causing the utilization (as a proportion of the total) to increase, causing your credit score to go down.


5. Myth: “I have fixed APR on my card – that means I have locked in the rate for life.”

No, “fixed” APR only means that your APR is fixed until the next time the card company changes your contract. Usually the changes to the APR on a “fixed” APR card do not happen too often, but still there are no guarantees that the rate is locked in for life.


6. Myth: “Once I payoff a collections account or an account included in bankruptcy, the negative record will be erased from my credit history.”

According to this Experian FAQ, any account included in a bankruptcy remains on your personal credit report for a maximum of 7 years from the date the bankruptcy was filed. The bankruptcy itself, listed in the public record information section of a credit report, remains for either 7 years from the filing date if it was a Chapter 13, or 10 years from the filing date if it was a Chapter 7, 11 or 12. According to this article, when your collections account is paid off, it will be marked “paid collection” on the credit report. Charged-off accounts remain seven years from the date of the initial missed payment that led to the charge off (the original delinquency date), even if payments are later made on the charged-off account.


7. Myth: “I only need to pay the minimum payments each month.”

This is a surefire recipe for disaster. If you pay only the minimum payments, it will take you a long time to clear your initial balance, during which time you pay an enormous amount in interest. Here is a bankrate.com calculator for calculating the true cost of paying the minimum payments only. For example, if your starting balance is $5,000 and your interest rate is 18%, if you pay only the minimum payment of say 2.5% of the balance, then it would take you 26 years to pay off your balance, during which you would have paid $7,115.42 in interest. If you have larger balance you can see how this could lead you to lifetime of being in debt and gigantic amounts paid in interest. So, if you have credit card debt start by paying as much as possible beyond the minimum payments to become debt-free sooner.


8. Myth: “I cannot keep up with my credit card payments – so I will consolidate all of them using a HELOC.”

If your HELOC has a much lower interest rate than your credit card payments and you know for a fact that you will be able to keep up with the payments, this idea may work. On the other hand, if you clean your slate of credit card debt with a HELOC and then start piling on more debt on your credit card, this could be disastrous. Eventually, when you cannot keep up with the payments on your HELOC since you have used your home as collateral you could end up losing your home!


9. Myth: “Having a rewards card will save me money.”

Not if you don’t pay off your balance in full each month! Rewards cards tend to have a higher interest rate than those with no cash-back or miles or rewards. So, if you do not pay off your balance in full, then the interest you pay might offset the benefits of any rewards.


10. Myth: “Credit cards are necessary for online shopping.”

Not quite. These days many, if not most, online merchants accept alternate payments such as debit cards, pay pal or e-checks. So it is not necessary that you must have a credit card account to be able to shop online.


11. Myth: “My divorce agreement states that my spouse is responsible for the debt on our joint credit accounts. If he defaults, I will not be responsible.”

A joint credit account that your share with your spouse is a responsibility of *both* of you. The law may have granted you a divorce and stipulated that your spouse should pay off the balance, but if he/she defaults, it will show up on your credit report as well, as the account is still jointly held from the creditor’s perspective. A divorce does not automatically break up joint accounts, and if you share joint account with your ex, it is advisable to call the creditor and either cancel the account or convert it to individual account. This article provides more information about divorce and credit.


12. Myth: “If you are only an authorized user and not a joint owner or co-signer, then your credit report will not be affected if the primary holder defaults.”

According to this bankrate.com article, if you are an authorized user you are not contractually obligated to pay the debt if the primary holder of the account defaults. However, the credit agencies consider you “guilty by association” and any activity on the accounts that you are an authorized user of will appear on your credit report. If it is negative activity, it will not have much bearing that you are only an authorized user, and your credit score can go down. By calling the creditor you can have your name removed as the authorized user, but it may take several weeks before this is updated on the credit report and the activity on the that account stops showing on your credit report (Note that earlier activity still remains).


13. Myth: “If I marry someone with a bad credit score, then my credit score will go down.”

Just as a divorce does not have any bearings on your credit report, a marriage does not automatically combine your individual credit reports either. However, after marriage if you open joint accounts and your spouse is irresponsible with it and causes negative marks, it will show up on both your credit reports.


14. Myth: “Credit repair agencies can help fix my bad credit history.”

If you have a negative record on your credit history due to a mistake on the part of the credit reporting agency, then the credit repair agencies may be able to help. On the other hand if there are legitimate reasons for your bad credit, then by law they will not really be able to help. What they can do is question the validity of some of the charges shown on your credit report. If the credit reporting agency can show the proof for these charges, then the credit repair agencies will not be able to erase them.



15. Myth: “Accepting pre-approved cards does not affect my score, since well, the offers are already pre-approved.”

As mentioned earlier, there are two type of credit pulls on your credit report – the soft pull that is not recorded and does not affect your credit score, and a hard pull that does. In order to determine candidate for receiving the pre-approved offers, marketing companies utilize soft pulls. However, if you apply for one of those offers, the company issuing you a credit card will do a hard pull on your credit history to confirm your credit worthiness. This can reduce your credit score slightly.

Those are some of the popular myths and misconceptions about credit related matters. Over the next few weeks, I will cover more about the common myths in other finance-related topics - so stay tuned. Once the series is complete, you should be able to access the full list of myths via this index.

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