While I have spent the majority of my life feeling like I was pretty good with my money, the older I get, the more there is to learn, understand, and navigate. Aside from the usual expected bills and rent payments, we also have to think about paying off student loans, buying new cars, making a downpayment on a house, and saving for retirement. If you're like me, these things can make your head start to spin. Throw in some credit card debt and suddenly, I'm not sure if it makes more sense to pay that off or opt in to my full time job's 401k program.
As I started to do my research and talk to friends and family in an attempt to figure out what made the most sense in approaching my own situation, I was immediately overwhelmed with information. While so much of the information made sense, a lot of it seemed contradictory and it became hard to know what was right from what was wrong. If there was one thing I learned, there's a lot of false information out there.
Clearly, I am no expert but lucky for you and me, there are people who specialize in and are paid to understand and help us break down the rhetoric of it all so we can make the decisions that are best for our personal financial situations. So what are some of the false facts the experts helped me squash? Let's get to it.
Keep a small balance every month on your credit card to build credit
For years, I was able to pay off my credit card balance in full each month and since I could, that was what I did, but then I started hearing people say that it was better for my credit if I left a little balance each month. I knew I had fairly good credit for someone my age but I wondered if I was hurting myself in the long run. "This couldn't be further from the truth," said finance professional Erica Holland of ModMoney, "but unfortunately, so many people believe it and pay thousands of dollars in interest expense as a result."
Holland went on to explain that the myth stems from the credit utilization factor on your credit score. "Potential lenders like to see that you can responsibly use and manage your credit lines without overextending yourself," she said, "The typical guidance is to keep your utilization below 20-30 percent. That means wisely using your credit cards throughout the month and paying off the full balance at the end." She continued on to explain that many people will misconstrue that to mean they should carry a balance of 20 percent of their credit limit.
Never close a credit card because it can hurt your credit score
I have a few credit cards, but lately I found myself feeling like it was time to pay one of them off and close it out. Truthfully, it can be so tempting to put a purchase on that card because I know it has the credit, but meanwhile, the question becomes if I can really afford what I'm wanting to buy or if it just feels like I can because I can put it on this card?
As I started to ask around, I started hearing rumors flying that closing out a credit card is going to hurt my credit score so I got a bit shy and have continued putting purchases on it throughout the month. Meanwhile, financial research analyst at MyBankTracker, Simon Zhen, was ready to put this idea into perspective.
"Generally, it is sound advice to maintain an old credit card account because it helps your credit score," he said. "However, if it carries high annual fees and encourages you to get into debt, you're better off closing the credit card account." He went on to add that closing the credit line may temporarily hurt your credit score but as long as you continue to use credit responsibly, it should recover just fine.
A low monthly payment means I can afford it
I recently turned 30 and have found myself toying with the idea of buying a house in the potentially very near future. As a single female, it may be a bit out of the ordinary but I'm feeling empowered and ready to plant some roots and build more personal equity, whether or not a man is in the picture.
With that said, I found Holland's opinion on the situation quite interesting and definitely worth mentioning. She started by saying that this idea that we can afford something simply because the monthly payment is low can often manifest itself in the form of a mortgage, car payment, or any other payment plan. "Consumers tend to hone in on the monthly payment amount, disregarding the term of the loan and the down payment," she said. "In reality, just because a car payment is only $179 per month doesn't automatically mean you can afford it. It's important to consider the required down payment and the lease/loan term, which can be very high and very long."
I've been saving up for my down payment, but I definitely appreciated the reminder and opportunity to think deeper into my situation knowing that there is another layer that we often overlook.
Focus all income on paying off debt instead of saving
When I graduated college, my parents gave me Dave Ramsey's The Money Answer Book and while at the time, we kind of laughed it off, I also knew they gave it to me for a reason. As previously mentioned, I considered myself pretty good with my money for years, but I also knew there was still a lot that I needed to learn and keep straight, and this book would provide a nice little resource when I found myself needing some guidance.
My biggest takeaway from that book and what often pops into my mind when I consider using my savings to pay off debt, is the need to have an emergency fund available. This point was also brought up by Zhen. "It makes sense financially to skip saving and put all income toward a 22 percent APR credit card or six percent student loan when savings rates are around one percent APY," he said. "However, there can be emergencies that set you back even more, if you didn't have an emergency fund to cover a surprise expense."
After a recent trip to the mechanic ended in needing new brakes and a replacement wheel bearing, you better believe I was happy to have that little stock pile set aside.