The recent passage of the Credit Card Accountability Responsibility and Disclosure Act of 2009 has prompted much discussion about credit card usage and debt. Given the global financial meltdown, it’s understandable that many are concerned about their own credit card debt and the practices of creditors in general. Unfortunately, these widespread discussions have given rise to numerous myths, half-truths and falsehoods about credit card usage and debt. Whether you are struggling with debt of your own or just striving to intelligently discuss the subject, it pays to debunk these myths and comprehend the relevant facts. Below are 12 long-standing credit and debt myths and the truths they obscure.
Ordinary Americans Have Long Used Credit Cards to Get By
Recent generations of Americans have gotten so cozy with credit card debt that it’s easy to imagine it’s always been this way. What was somewhat common prior to the 1980′s were store credit cards, such as those issued by Sears or Montgomery Ward. Unlike general, all-purpose Visa or MasterCard credit cards issued by banks, store credit applied only to purchases from the issuing store. That is, one could not use a Sears credit card to go hog wild with debt at every other store that caught his eye. Generally, such cards were issued to promote consumer loyalty and increase sales. However, as a November 2009 Kiplinger infographic shows, Visa use began steadily rising in 1990 (when it accounted for roughly $150 billion in consumer spending) until finally, in 2008, $800 billion in consumer spending was done using Visa cards alone. While not all of this increased credit card use is categorically bad or wrong, the rate at which it has risen is truly staggering, especially in light of how many people currently find themselves over their heads in debt.
The CARD Act is a Blessing For Those Already in Debt
The aforementioned Credit Card Accountability Responsibility and Disclosure Act of 2009 has generated substantial debate, with supporters regarding it as assisting those in debt and critics alleging it falls short. Regardless of the particular merits or demerits of this law, one thing is clear: it does not offer very much to those who had debt before it was passed. Because Congress signed the bill into law with a nine month delay before it took effect, creditors had ample opportunity to raise interest rates, reduce lines of credit, impose fees and other actions now prohibited by the Act. Essentially, Congress gave the banks and creditors plenty of time “get their last licks” in before the bill became law. On the bright side, it does prohibit some long-criticized practices of banks and creditors, such as enabling overdraft “protection” by default, unannounced rate hikes, and many forms of marketing to those under the age of twenty-one.
More People Have Credit Cards Because Creditors Got Better At Managing Risk
Partially, but not completely. According to the Washington Post, far more instrumental is how “industrial restructuring shifted demand for bank loans from manufacturing companies to individual households, and national banks aggressively pushed for more deregulatory policies” following the 1981-82 recession. Furthermore, prior to a 1996 Supreme Court ruling that “ended state-regulated limits on credit card fees”, creditors were generally prohibited from charging interest exceeding 15%. The abolition of this regulation extended credit to throngs of lower-income borrowers whose riskiness to creditors could not be profitably assumed under the interest rate cap. Thusly, it is not so much that the creditors got “better” at managing risk as it is that they were finally permitted to charge interest that reflected the risks of lending to lower-income borrowers.
Credit Consolidators Can Cut Your Monthly Payments in Half
With a seemingly endless parade of TV and radio commercials making precisely this claim, how can it possibly be untrue? Well, it isn’t always untrue. But as Bankrate reminds us, the promise by consolidators to cut your monthly payments in half is “a numbers fudging claim that holds true only in the narrowest of circumstances.” Let’s say, for example, that you miss two $200 payments on a $10,000 balance, making it so that you now owe $600 on the third month’s bill. What the debt consolidator will likely do is “re-age that bill, knocking your payment amount back to $200.” However, it should be obvious that you don’t magically owe $400 less than before. That amount is simply “tacked back onto the total owed.” Only by verbal gymnastics and sleight of hand can credit counselors spin such maneuvers as “cutting your monthly payment in half.”
Closing Accounts Will Boost Your Credit Score
It sounds logical, doesn’t it? Close out a few credit cards, many people assume, and you will therefore look like less of a gamble to prospective creditors. However, this is not how credit reports generally reflect the closing of accounts. Quite the contrary – because credit scores consider “the difference between your available credit and what you’re using”, MSN explains, closing accounts shrinks your total available credit, thereby “making your balances loom larger, which typically hurts your score.” Yes, it’s true that you should not open a ton of accounts to begin with, but if you have already opened them, closing them now will not help your credit score. Furthermore, since credit scores also track how long you’ve been with a given creditor (and favors lengthier relationships), closing older accounts can weaken your credit score even more. The correct advice to people considering closing accounts is to resolutely repay their debts as fast as possible. It’s not fancy or easy advice, but it is guaranteed to eventually help your score, while closing accounts is guaranteed to immediately hurt it.
Checking Your Own FICO Score Can Hurt Your Credit
Incorrect. What generally hurts your credit is excessively applying for credit, such as filling out dozens of store and bank credit card applications in a year. This specific fact has often been erroneously extrapolated by financial “gurus” into the generic advice that your credit is hurt every time someone – anyone – pulls your report. In reality, however, you ordering a copy of your own credit report or score has absolutely no bearing on that credit report or credit score. A Buzzle.com article likewise confirms “the FICO scoring formula ignores any inquiries that you make on your credit report”, as this is considered a “soft” inquiry. Again – the inquiry-related damage to your score is done by creditors pulling your report, and even then, only once you have applied for credit from them. So don’t be shy about examining your own credit report in as much detail and as frequently as you’d like.
FICO Scores Only Change in 6 Month Increments
For one reason or another, it has become commonly accepted that FICO scores only change every six months, so that making changes today, tomorrow or next week may not add up to anything beneficial for a long time. Fortunately, this myth has absolutely no basis in reality. FICO scores are dynamic and regularly change in response to updates to your credit report without any substantial amount of time needing to pass first. Bankrate.com quotes Fair Issac Corp public relations manager Craig Watts, who confirms that “when we calculate a score, for all intents and purposes it then goes away and is recalculated the next time someone pulls your file.” Therefore, anyone holding off on repaying debt, disputing an erroneous credit report entry or taking other positive actions due to fears that it “won’t matter for a while anyway” now has one less excuse to wait!
Responsible Cardholders Will Now Be Stuck Paying For The Deadbeats
While this is generally true, it is not as applicable to the current debt/financial crisis as many seem to believe. Rather, the Washington Post states that while credit card companies are “experiencing record default rates”, irresponsible consumer borrowing is nevertheless “not the main culprit behind soaring interest rates and fees.” The driving force behind these, the Post contends, are “mortgage foreclosures and home-equity loan defaults”, which are swallowing banks in record numbers. Consequently, “bank revenues have declined sharply, raising pressure on credit card companies to boost profits” amidst the global recession. So contrary to rate hikes during prosperous times, when irresponsible borrowing can be assumed as a primary cause, other factors are clearly at work during 2010.
Credit Counseling is Damaging to Your FICO Score
Whatever truth this belief once had is now gone. According to MSN, the FICO score calculation formula has “ignored any reference to credit counseling that may be on your file” for at least the last three years now. The reason? Researchers at Fair Issac are constantly analyzing default activity for patterns among debtors who have the same characteristics, and simply put, the data revealed that “people getting credit counseling didn’t default on their debts any more often than anyone else.” While it’s true that credit counseling could make it more difficult to get a loan, these risks stem from things like your credit counselor not sending in your payments on time, not from anything inherent in credit counseling as such. Therefore, if you believe credit counseling can demonstrably improve your credit and have a reputable firm to work with, there is nothing to support the idea that credit counseling will hurt your credit.
Repaying All Outstanding Debts Instantly Restores Great Credit
Earlier in the article, we refuted the myth that credit scores take an arbitrary six month period to recalculate. However, it’s also true that repaying all your debts doesn’t instantly elevate your credit score to the heavens. The reason, according to Bankrate, is that your credit report is “not just a snapshot of where you are at the moment” regarding credit and debt, but rather a “history of your payments.” In other words, the fact that you do not currently owe any money to creditors does not completely erase the fact that you did owe a substantial amount for several years. Of course, none of this is to imply that you shouldn’t pay off your debts. While it won’t immediately give you amazing credit, the only way you will ever get amazing credit (assuming you want it) is to eventually become debt free or close to debt free. Just don’t fret when it takes a little time for creditors to see that the new, debt-free you is the norm rather than the exception.
FICO Scores Aren’t The Only Scores You Should Check
There is actually a small grain of truth to this, but it is still misleading enough to be a myth. While each of the “Big Three” credit bureaus offer FICO credit scores using the same formula developed by Fair Issac, much confusion results from the fact that each bureau calls this score something different. TransUnion, for instance, calls its score “Empirica.” Equifax, on the other hand, refers to its FICO scores as “Beacon credit scores.” At Experien, the FICO is known rather abstrusely as the “Experian/Fair, Issac Risk Model.” And it’s true that these scores will sometimes be slightly different, simply because all three bureaus don’t always share the same data. However, despite the different and confusing names, the basic model used to assess your FICO score is the same at all three, and the FICO score is indeed what these names refer to. Moreover, the correct advice on improving each of these scores is the same: generally speaking, that you should promptly repay outstanding debts, be vigilant about errors on your report, stay on the lookout for identity theft risks and be selective in how many credit card applications you submit.
The Majority of Americans Have Staggering Credit Card Debt
While credit card usage has undeniably increased over the years, it is by no means clear that most Americans are struggling with credit card debt. In fact, relevant studies show that the exact opposite true. CreditCards.com, for instance, cites a 2009 Federal Reserve Board survey of consumer finances which revealed that “as of 2007, the majority of U.S. households had no credit card debt.” That same survey found that “of the 73.0 percent of families with credit cards in 2007, only 60.3 percent had a balance at the time of the interview.” Another study cited on the same webpage (this one from MyFICO) shows that “about 40 percent of credit cardholders carry a balance of less than $1,000.” None of this negates the huge balances that some (perhaps even many) Americans have, but it serves as a reminder that perhaps some of the heated political rhetoric about the prevalence of overwhelming debt is a bit more exaggerated than the facts warrant.