How To Build Credit: Busting Common Myths

On the surface, the idea of building credit may seem straightforward: You borrow money, and by repaying it on time, you prove you’re a trusted borrower. However, between juggling multiple lines of credit, managing debt and decoding your credit score, there’s a lot more to the story. Because of this, misleading advice and myths about the best ways to build and maintain credit are everywhere – making it difficult to decipher which tips are truly helpful.

Here, we’re debunking some of the most common credit myths to help you make well-informed financial decisions.

Myth No. 1: You Need To Carry Debt To Build Credit

While the process of building credit does involve borrowing, it’s the responsible use of debt that builds your credit history and score. For example, taking out a $40,000 auto loan does not automatically boost your credit. What does, though, is consistently making your payments in full and on time.

The same logic applies to credit cards. A common misconception is that leaving a balance month-to-month helps build credit – but this can actually do more harm than good. Suppose you spend $5,000 on your card in May, but only pay $3,000 when the bill comes due. That remaining $2,000 carries over into the next month – and especially if the balance exceeds 30% of your credit limit, it can negatively impact your score. On top of that, carrying outstanding balances can bring extra interest charges, causing you to pay even more than what you spent.

The best practice? Use your credit card but pay your balance off in full each month to avoid unnecessary expense and build up your score.

Myth No. 2: Checking Your Own Credit Score Could Lower It

Your credit score – a number typically ranging between 350 and 800 – is a rating of your creditworthiness: The higher the score, the more likely you’ll get approved for loans or be offered better lending rates. This score is based on multiple factors, such as how timely your payments are, how many lines of credit you have open and more. However, how often you check your own credit score has no impact on it.

Even so, keeping track of your own credit is a smart financial habit. As you work on building and maintaining a strong credit score, it can help you stay informed, track your progress and alert you to any errors or inconsistencies. To check yours, consider using reputable services like Credit Karma or Experian – but know you can also usually check it through your bank or credit card issuer as well.

Part of this misconception is due to a misunderstanding of the difference between soft and hard inquiries. When you check your own credit score, it’s considered a soft inquiry – harmless to your credit. When a lender checks your score as part of a credit application, though, that’s a hard inquiry. These can temporarily lower your score by a few points, especially if multiple hard inquiries happen in a short span, which may signal risk to lenders. That said, hard inquiries are a necessary part of applying for credit – like when renting an apartment or taking out a mortgage – so they shouldn’t be feared, just managed thoughtfully.

Myth No. 3: You Have One Universal Credit Score

While you may commonly hear people ask, “What’s your credit score?” leading you to believe you only have one, that’s actually not the case. For example, the score your credit card company shows may be 720 – but if you check your score on a site like Experian, it may come back higher or lower. This is because different credit scores are calculated using different scoring models and data from different credit bureaus.

The three major credit bureaus – Experian, Equifax and TransUnion – each collect slightly different data based on your credit activity. Then, scoring models like FICO or VantageScore apply their own formulas to that data. Lenders also choose which bureau and model to use depending on what type of credit you’re applying for. So, while your scores should generally fall within a similar range, it’s normal for them to differ depending on where and how they’re calculated.

Myth No. 4: Income Affects Your Credit Score

If you’re applying for something like an apartment, auto loan or personal loan, you may be asked to provide your income on the application. While this likely will be taken into consideration when lenders decide whether to lend you the cash, your income itself is not factored into your credit score. Really, they’re checking to see if you have enough income coming in to pay back the loan in full and on time – which, when paired with how high your credit score is, gives them a good look into whether you’re a trustworthy borrower.

Myth No. 5: Cosigning a Loan Automatically Decreases Your Credit Score

In some cases, especially for those who have little credit history, a lender might not accept a credit application on its own – they might instead require someone with a good credit score to cosign on the application. Cosigning means you agree to take equal responsibility for the loan – so if the primary borrower can’t make payments, the lender will look to you to cover them.

For example, a lender might decline the application from someone just starting out with a short credit history asking for a $50,000 personal loan. However, if that same borrower were to apply with a cosigner – like a parent – who has decades of credit history and a strong credit score, the lender is more likely to agree to the loan. While this doesn’t affect the cosigner’s credit score immediately (aside from the hard inquiry), it will once you start making payments on the loan. Make them on time and in full, and their credit score will only benefit from it. Remember, though, that the opposite rings true as well – failing to make proper payments can lower their credit score as well as yours, as well as open the door to potential legal action.

Myth No. 6: Opening Multiple Credit Cards Helps You Build Credit

The types of credit you have – known as your credit mix – count for a portion of your credit score.  Credit bureaus like to see how you manage credit across different types of accounts, like credit cards, student loans, auto loans, retail accounts and mortgages. While having two or three well-managed credit cards can be beneficial for your score, it’s much more important to diversify your credit types. And remember, if you open too many credit cards at once, your credit score could decrease pretty quickly due to the hard inquiries. Plus, having more cards increases the potential for overspending or missing payments, which could also lower your score.

Myth No. 7: Closing Accounts Improves Your Credit Score

If you’re looking for ways to boost your credit score, simply closing a few accounts likely won’t create the result you’re looking for. Some of the main factors considered in your credit score are your credit utilization ratio (how much credit you have available versus how much you actually use), the length of your credit history and your credit mix. If you close an account, you can hurt all of these factors – you’ll decrease your usage, potentially shorten your credit history (especially if the account has been open for a while) and subtract an account from your credit mix. Because of this, it’s generally better to keep accounts open and simply use them responsibly.

Myth No. 8: A Few Mistakes Will Prevent You From Qualifying for Credit

Following the rules that come with building a strong credit score is much more easily said than done – and after all, we’re human, and we all make mistakes. While it’s true that actions like missed payments, defaults or even bankruptcy can negatively affect your credit score, they don’t follow you forever. In fact, negative credit report information expires over time: Missed payments, foreclosures, repossessions and bankruptcy expire from your report after seven years. While these actions may hurt your score while they’re on your report, the effect will lessen over time – especially if you adopt healthier financial habits going forward.

A blemished credit history doesn’t mean you’ll never qualify for credit again. Many lenders even offer credit-building tools and secured credit cards designed to help people rebuild responsibly. If you find yourself in this position, take the opportunity to take charge of your credit – and take small steps to boosting your score right back up.

A strong credit score can unlock many opportunities for you financially, from buying a home to starting a business and more – so understanding the do’s and don’ts of building credit is vital. If you have any questions about how you can make the most of your credit situation, reach out to your Baird Financial Advisor team.

The information offered is provided to you for informational purposes only. Robert W. Baird & Co. Incorporated is not a legal or tax services provider and you are strongly encouraged to seek the advice of the appropriate professional advisors before taking any action. The information reflected on this page are Baird expert opinions today and are subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor and investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor before taking action.