6 common credit card misconceptions

Written by
Geoff Williams
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With a new year underway, you’ve had some time already to work on your resolutions to get your credit card spending under control or to use your cash back savings rewards better than you have in the past. We hope those resolutions are going well, but it’s also worth asking at this point: Are there any common credit card misconceptions that are holding you back?

Maybe you aren’t asking it exactly like that; perhaps it’s more of a “What am I missing?” But that’s why credit card misconceptions are so tricky and dangerous. Nobody ever thinks to themselves before applying for a new credit card, “Gee, maybe what I think I know about credit cards isn’t quite right.”

No, we just all go ahead, apply and use the card.

But if you’re looking to use your credit cards better – because some of us are – consider whether you have the wrong idea about these common credit card misconceptions.

Are credit cards for emergencies?

Ideally, no, they aren’t. Look, if you have a financial emergency and the only safety net you have is your credit card, obviously, you do what you have to do and use it. But credit cards are cash flow tools and, because of the features credit cards have to entice you to use them, they are also financial instruments that can even help you save money (or spend quite a lot of it, but that’s another article).

But the last thing a credit card should be thought of is as a nest egg to use in emergencies. That’s what a savings account is for. The moment any of us decides that credit cards are designed for emergencies and we stop putting money regularly into a savings account, we have a problem.

Because if you put $5,000 in unexpected car repairs on a credit card, you still have to pay off that credit card, and very quickly if interest will kick in the following month (and not as quickly if you’re in the midst of an 0% APR deal). But if you can pull out $5,000 from your own savings account, then you can take your time replenishing your savings account. (Not too much time, though, since you could have another financial emergency come down the pike.)

Do you need to carry a balance to improve your credit?

No, you don’t need to carry a credit card balance to improve your credit. Some personal finance experts in the past have suggested that, and it may be true that carrying a small balance on a card or two may improve your credit score, but it’s also true that it may hurt it. There are so many variables going on with a credit score that it’s really impossible to say whether carrying a small balance is going to hurt or help your credit score.

But here’s what is clear: If you can pay off your credit card in full every month, do that. Don’t carry a balance, thinking that may help your credit score. Lenders do like to see credit card borrowers using their credit cards, but they want to see them making regular payments, preferably in full. Your goal should be to pay your credit cards off in full every month – and to try to not borrow more than 30% of your available credit (borrow more, and lenders get nervous, and that’s when your credit score can start to tumble). Furthermore, no amount of incremental positive impact on your crdit score is worth paying interest.

If you’re otherwise responsible, your credit score will be just fine and you’ll avoid interest charges.

Does your income affect your credit score?

Your income does not affect your credit score, but it’s easy to see how some people might think that since your income can determine whether you get approved for a credit card. But it’s a trap to assume people with big incomes also have big credit scores and vice versa.

Your actual credit score isn’t impacted by whether you make $10,000 a year or $10 million. What matters is that you pay off your bills in full every month and handle your available credit responsibly. If you’re a billionaire who routinely fails to pay your bills on time, your credit score will suffer.

Does applying for a new credit card hurt your credit?

Generally, no, it will not, at least not long term. Why the wiggle room with “generally”? Because, again, a lot of factors go into the health of your credit score. But for most people, applying for a new credit card isn’t going to hurt your credit score. You might see a couple of point drop in the immediate aftermath of applying — that’s because of the hard credit pull — but that should quickly bounce back with the decreased credit utilization having a new line of credit brings.

What can hurt your credit score is if you apply to several new credit cards at once. Sometimes lenders will see that as a sign that you’re desperate for money, and if you’re desperate for cash, then they worry that you may have trouble paying back a loan.

In fact, applying for a new credit score may help your credit score – at least for awhile. The more available credit that you have, that you aren’t using, the better. Lenders like seeing that Phil in Chicago has $15,000 in available credit that he never uses. Now, if you get a new credit card with a $15,000 available credit limit, and you max it out, then, yes, your credit score will likely start to collapse, unless you pay it off really quickly.

Will canceling a credit card help your credit?

Canceling a credit card is unlikely to help your credit and may, in fact, hurt it. In particular, that could happen if you close the card you’ve had the longest. Credit bureaus like it when borrowers have had credit accounts open for a long period of time; they see that as a sign of financial stability and experience handling credit. For that reason, it’s often a better idea to product change to a more appropriate card rather than close a card.

Your credit utilization ratio also increase, and thereby ding your credit score, if you close a credit card.

Let’s create a math problem:

Let’s say that you have three credit cards, all with $10,000 credit limits.

Card A has $10,000 in available credit, and you never use it.

Card B has a balance of $5,000 (so $5,000 in available credit).

Card C has a balance of $5,000 (so $5,000 in available credit).

Right now, even though you owe $10,000 (you really should pay that off), you still have $20,000 in available credit. Lenders see that as responsible. All of that available credit, and you aren’t using it. In fact, you could owe $30,000 in debt right now, but you only owe $10,000. About a 33% credit ratio utilization. Not great, but not too bad.

But then you decide to close Card A since you never use it, and now you have a $20,000 credit limit across two cards, and geez, you’re borrowing half of that. Suddenly, even though you simply canceled a credit card and did nothing else, you look like a less responsible borrower in the eyes of credit bureau algorithms.

Look, sometimes you have to change up the credit cards in your wallet. If you don’t use one much, and there is an annual fee, it’s worth considering whether to close it. If you believe you’ll max out the card because your willpower is at an all-time low, then cancel it. But if you’re just trying to simplify your life and get rid of an extra credit card, there is a decent argument for simply hanging onto it and making it a “sock drawer” card.

Do credit card APRs ever change?

Credit card APRs change all the time for a variety of reasons. Interest rates are tied to the national prime rate, which is tied to the Federal Reserve rate; therefore, anytime the Fed changes the rate, your credit card interest rate is likely to change as well.

We hope this isn’t a common credit card misconception. Still, it can be all too easy to forget that the interest rates can and almost certainly will change over time — banks can also adjust them without the Fed doing anything — and you have to keep in mind there are several different APRs for a given card.

For instance, with any credit card, there could be the:

Purchase APR. This is the annual percentage rate, and whatever the rate is, is the cost of borrowing money on the card. If you have 0% APR, which is often the case when you apply for a new credit card, eventually that rate is going to disappear and be replaced with something less awesome, like 17.74% or 27.74%.

Cash advance APR. If you were to borrow cash from your credit card – and generally, that’s a terrible idea – you’ll likely be charged a higher APR than your normal APR, and the interest kicks in from the second you borrow the cash (there’s no grace period to pay it back in full, without interest).

Penalty APR. If you don’t fork over the minimum payment on your credit card, your card may sock you with a penalty APR. Typically, these kick in after about two months of not making your payment, and for a period of time, usually six months, you’ll often pay a higher APR when you carry a balance for at least six months.

And if you aren’t careful with your credit card, you could be paying numerous APRs at once. For instance, after six months of paying a penalty APR, as long as you’ve made six consecutive on time payments, your card has to bring the APR back down to the normal variable APR on any existing credit card balance that you’ve been carrying – but you still might have to pay a higher penalty APR for anything new that you purchase.

The bottom line on common credit misconceptions: People often say that what you don’t know won’t hurt you, a dangerous misconception when it comes to your credit cards.

Geoff Williams
CardRatings Contributor

Geoff is a freelance journalist and has been since the 1990s. He specializes in personal finance and small business issues and has seen his work published with numerous news outlets including The Wall Street Journal, CNNMoney.com, Reuters, The Washington Post and Consumer Reports. He also...Read more

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