Debt Myths

    Erase DebtStories about the Loch Ness Monster, George Washington having wooden teeth and cracking your knuckles causing arthritis are nice pieces of fiction with no proven basis in fact.

    In other words, they’re myths.

    Myths are popular, but are built on a flimsy foundation of misinformation. It happens with a lot of subjects and debt no stranger to myth.

    Despite what you have heard, it is not wise to close old credit card accounts and paying off all debts does not mean you’ll have a perfect credit score. Those are just two of many myths we will try to straighten out on this page.

    Let’s start, however, with a factual premise: Debt is a way of life for 99.9% of American adults. It is a necessity in today’s economy where it’s commonplace to be paying on credit card debt, student loans, mortgages and last month’s utility bills every month.

    An affordable amount of debt helps individuals reach their goals and live comfortably, but if debt is unchecked or uncontrolled, it becomes a debilitating weight.

    A basic understanding of debt facts — and yes, knowing how to pick out the pesky myths, too — can help you make more informed decisions about your financial well-being.

    Here are 15 common financial myths … and the truth that goes with them.

    1. Myth: Once you marry, you’re responsible for your spouse’s debt.

    Many couples believe that when you get married, there is a merging the debt loads. Generally, that’s not the case. It’s common for couples to pay down debt together, but neither spouse is legally obligated to pay off debt that the other incurred before marriage, according to John Ulzheimer, president of consumer education at SmartCredit.com, a credit monitoring service.

    Of course, there are ways that protection could be lost once you are married. You could be responsible for debt your spouse takes if you put your name on a loan’s promissory note or if you are added as a joint account holder of a credit card.

    2. Myth: Credit cards from retailers are a good deal.

    Um, not really. Read the fine print, especially the part about what happens if you carry a balance from one month to the next. Retail credit cards can sound enticing, especially when you are offered interest-free financing and rewards, but if you carry a balance, things go south in a hurry. Some cards resemble payment plans, where borrowers make a card purchase from the retailer, then can pay it back over several months, interest-free. But what if you don’t pay off the whole balance in the allotted time? You’ll typically pay interest on the entire amount you initially charged — retroactively — usually at a much higher rate than a typical credit card. For example, Apple offers customers up to 18 months interest-free on purchases on a card from Barclaycard US. But if you don’t pay off the purchase in the interest-free period, a variable annual percentage rate (about 23%) kicks in, according to the Apple website. Your history doesn’t matter. Even with excellent credit, you could find yourself paying upwards of 20% interest. Repeat: Read the fine print.

    3. Myth: You looked it up, so you know your credit score.

    There are numerous places to get a “free credit score,” but that score probably is not the same as the one your lender receives. It might be better, it might be worse, which begs the question:

    How many credit scores are there? Dozens, maybe more. There’s the widely-used FICO score, of course, and you probably know that one well. But there are actually 60 slightly different variations of FICO. Based on the credit you are applying for, lenders may pull a different score.

    Example: For mortgages backed by Fannie Mae or Freddie Mac, lenders usually pull three FICO scores available directly from each of the three major credit bureaus. If you’re applying for an auto loan or credit card, the lender will usually pull a score tailor-made for that kind of credit product. Why are there so many credit scores? The three major credit bureaus — Equifax, Experian and TransUnion — might have different information about you, so the scores could vary. Why the discrepancies? Some lenders don’t report to all three bureaus. And some bureaus might be behind in updating your report. Also, there are multiple credit scoring models based on scores from 300 to 850 and variations within each scoring model tailored for specific lenders. FICO has nine versions of its basic scoring model. Within the models, there are specialized versions that assess the risk of providing mortgages, auto loans, bank cards and installment loans. Don’t worry about getting lost in the shuffle. It’s impractical to follow all of your scores. Follow one or two available to you and always ask questions if you detect any large changes.

    4. Myth: Closing unused lines of credit — or lowering your credit limits — will boost your credit score.

    Incorrect. Closing a line of credit might help undisciplined spenders to reduce their total debt load, but when it comes to your credit score, this method can do more harm than good.

    Your FICO score takes into account when you opened each line of credit. Older accounts help your score, particularly when you have made timely payments. When you close an older account, you lose that age advantage and your credit history seems younger and could actually go down.

    5. Myth: Paying off debts will instantly repair a credit report.

    Nope. Credit reports provide an overview of your current credit standing and your credit history. Most negative information stays on your credit report for seven years. Chapter 7 bankruptcy stays with you for 10 years. Paying off debts will improve your credit report and credit score, but it won’t erase past problems. That requires time.

    6. Myth: Checking my credit report will lower my credit score.

    Untrue. The government encourages you to check your credit report at least once a year. In fact, you’re entitled to one free credit report every 12 months from each of the three national credit bureaus. When determining your score, the FICO credit scoring model ignores your requests for your credit report, so those requests do not lower your score.

    7. Myth: Credit repair services can fix a credit score.

    Credit repair companies can’t do anything you couldn’t do yourself. Repair companies could charge you money, then provide no results. Remember, NO ONE can legally remove accurate and timely information from a credit report. It’s also illegal to create a new identity to have a new credit report. Repeat: Beware!

    8. Myth: A divorce decree will separate joint accounts.

    Nope. The decree will not affect joint accounts. In fact, even after a divorce is final, your ex-spouse’s bad credit practices may continue to appear on your credit report. That’s the case if the decree states that your ex will be fully responsible for certain accounts. To prevent this from happening, you must contact the creditor for each join account. Possibly, one name could be removed, transforming it into an individual account. Or you could close the account, then open a new one to replace it.

    9. Myth: It’s OK to make minimum payments on a debt.

    It’s OK if you want to pay a high interest rate and be in debt far longer than necessary. It won’t cost you late fees and it won’t have negative consequences on your credit report, but it’s far more prudent to pay off an account in full every month, or at least increase your payments to something above the minimum. Once you crunch the numbers, you’ll never look the same at minimum payments. Let’s say you have a $5,000 credit card balance. With a projected minimum monthly payment of $100 — 2% of the total debt — and an annual interest rate of 15%, it will take you about 24 years to pay off the balance and cost you more than $7,000 in interest. What happens if you increase the monthly payment to $125? You will only need five years to pay off the debt in full. And you will save more than $5,000 in interest. Still want to make that minimum payment?

    10. Myth: All debt is a bad thing and only hurts you.

    Believe it or not, there is such a thing as “good debt.” You can borrow money to help increase your net worth or earn more money. Put student loans, mortgages and small business loans in the “good debt’’ category, but keep in mind there are no guarantees. A good education may not secure a high-paying job. A home may depreciate in value. A small business may not become profitable. The bottom line is making sure you can afford to repay good debts and keep your accounts in good standing.

    11. Myth: If you have a large amount of debt, your only option is bankruptcy.

    No, no, no. Bankruptcy should be your last option, only after considering all other alternatives. You might be able to solve your problems with a debt management plan or through debt settlement. Debt management combines several loans into a single, larger loan. This new debt simplifies your monthly bills and typically lowers your interest rate. Debt settlement is a method of negotiating with your creditors to have part of your loan erased. A successful debt settlement reduces the amount of money you’re responsible for paying back.

    12. Myth: Bankruptcy hurts a credit score so much that you will never be approved for credit again.

    Never, as they say, is a long time. If you’re going down the road toward bankruptcy, your credit score is already damaged from late or missed payments and a high amount of debt. Declaring bankruptcy may not hurt your score as much as you think. According to the Fair Isaac Corporation, if you have a starting score of 680, bankruptcy could knock it down 130 to 150 points. That’s an estimation. It’s impossible to predict the exact consequences. Even with a reduced credit score, you could still be approved for a line of credit. Many lenders no longer view bankruptcy as a deal-breaker when approving and denying credit applications. Bankruptcy can free up some of your income, helping you to pay future debts. Remember, too, that bankruptcy isn’t forever. It is typically removed from your credit report after 7-10 years.

    13 Myth: You’re too rich for federal student loans.

    There is no income cutoff to qualify for federal student loans. Unfortunately, if a family is well-off financially, they figure they won’t qualify for federal aid and don’t even apply. Some years, as many as 41% of families earning $100,000 or more didn’t even file the Free Application for Federal Student Aid (FAFSA), which is necessary to lend federal loans. Private loans often have higher rates or rising variable rates. Most lenders encourage trying for federal loans, regardless of your income.

    14. Myth: Paying off your mortgage each month will do wonders for your credit score.

    FICO’s typical scoring model will cut your score for missing mortgage payments, but making payments on time does not have much impact on your credit score. Why? In FICO’s models, missed payments are more indicative of your riskiness than regular on-time payments.

    15. Myth: A late credit-card payment will damage your credit.

    Late payments aren’t good. They bring fees. They create interest charges. But they won’t necessarily affect your credit report. Companies usually don’t report a late payment to a credit agency until it is 30 days past due. Medical debt, meanwhile, won’t show up until the bill goes to collection.

    Bill Fay

    Bill Fay is a journalism veteran with a nearly four-decade career in reporting and writing for daily newspapers, magazines and public officials. His focus at Debt.org is on frugal living, veterans' finances, retirement and tax advice. Bill can be reached at bfay@debt.org.

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