Your credit report is a report card of your credit history. It's filled with information about past payments, inquiries and more. Having a positive credit history can save you tens of thousands of dollars on mortgage loans, car loans and other credit, so understanding how it works is critical. Below are common misconceptions about credit.
Bounced Checks Impact Your Credit
An overdraft shows that you've been irresponsible with your bank account, but it doesn't affect your credit in any way. Your credit report is only made up of information from credit-related activities. Credit cards, student loans, auto loans, mortgages and lines of credit are the most common accounts on a credit report. If you go into collection from not paying a bill, that may also be reported to the credit bureaus.
Anything related to checking, savings and other non-credit accounts will not go on your credit report or affect your credit score.
Checking Your Credit Report Hurts Your Score
Ten percent of your credit score is determined from the pursuit of new credit, measured by inquiries made on your credit score over the prior two years. However, not all inquiries are the same. Inquiries related to applying for new credit are considered a “hard inquiry” on your credit report. These are the inquiries that affect your credit score.
Any other inquiry is considered a “soft inquiry” and has no impact on your score. Examples of soft inquiries include those that you initiate yourself, credit updates by banks where you have existing accounts and credit inquiries used to market new credit products to you. (For more, see 3 Important Credit Score Factors.)
Closing Unused Accounts Isn't Always a Good Idea
One factor in your credit score is the average age of open accounts. As a general rule, old accounts with a positive history help your credit score. If you close them, it lowers your average open account age and can harm your credit score.
All open credit accounts are reported on your credit report. When you close them, they typically remain on your account for seven years before they drop off. Unless there is an annual fee or negative information associated with the account, it is best to keep it open as long as possible to help increase your score. (For more, see The 5 Biggest Factors That Affect Your Credit Score.)
Opening a New Credit Card Will Lower Your Score
It's true that a new card will lower your score — but only temporarily. In the long run, it's likely to have a positive effect on it. New credit reduces both your credit score and your average age of credit. As the account ages, your average account age improves. Additionally, having a larger number of open accounts that are well-managed shows lenders that you're a responsible borrower.
If you plan to buy a new home or apply for a new auto loan in the next year, opening credit cards will not help your chances. However, if you don't have those plans, you can safely open new cards as long as you can responsibly make all required payments on time without worrying about your credit score.
Using Cards Each Month Will Improve Your Credit
As long as an account is open and in good standing, you don't have to use it every month to build your credit. Some banks close accounts that haven't been used in a while due to inactivity, so it's a good idea to use every card at least once every six months to keep it active. Otherwise, keeping a zero balance is the best thing for improving your credit report and credit score.
The Bottom Line
Your credit report and credit score are two of the most important tools you have to manage your personal finances. To achieve the best results, think ahead before making any decisions that could impact your credit.