Drawbacks of Credit Cards and Credit Use
One of the primary reasons consumers run into credit issues and subsequently suffer with a low credit score is too much credit card debt. Excessive and unmanageable credit card debt not only causes credit and credit score problems but also is a primary cause of personal bankruptcy filings.
The use of credit usually involves spending money that is not readily available. Obtaining a home mortgage is one form of credit in which borrowers use the money extended with the credit to buy a house. Most individuals would not have the cash available to buy a home without credit being extended with a mortgage. Historically, obtaining a mortgage to buy a house has been a sound use of credit since the borrowed funds were used to purchase and asset, and that asset usually appreciates in value while the debt obtained to buy the assets is reduced in value over time with monthly mortgage payments.
Credit card debt is also used to make purchases with money not readily available, similar to mortgage loan used to buy a house, but credit card debt is usually incurred to purchase disposable items not assets. Credit card purchases are rarely used to buy an asset that is going to appreciate rather they are used for toys, trips, TVs and related consumption goods.
Since consumers can spend more than they currently have with credit, they can easily spend more than they can afford. This is true when credit is used to buy a home but is especially true or more common when credit cards are used. The primary reason is that access to credit cards has been relatively easy and accessible allowing more consumers to lose control over this type of credit.
With credit card use, as the credit card balance increases with purchases and other transactions, the minimum monthly payments also increase, and soon many credit card users find themselves in over their head. This problem is exacerbated if interest rates on the credit card are high or have become high due to late payments and the credit card fees are accumulating. Unmanageable credit card monthly payments tens to lead to late payments and a deteriorating credit history.
Credit card debt generally carries a high interest rate. When someone buys a home, the interest rate on the loan is often 10% lower than the rate on a credit card. Since credit cards are so prevalent, very few consumers pay attention to just how expensive credit card debt is.
Due to these high interest rates, the minimum monthly payment on the total balance due may cover little more than the monthly interest charge. Consequently, the minimum payment may only minimally decrease what is already owed. The low minimum payments, high interest rates and ease of access frequently adds up to trouble for many consumers who end up struggling to pay off the debt they have accumulated to buy everyday items. The end result is a poor credit score, added stress and a decreased standard of living.
Many credit card holders try to manage the high interest rates by accepting promotional credit card offers to transfer credit card balances or open new credit cards with a lower rate. Often these moves simply exacerbate the debt load problem by adding new debt without paying off the accumulated credit card debt.
Some of the reason that new low rate credit cards and balance transfers fail to help is that the low rate offers may be offered on balance transfers with new purchases and cash advances are billed at a higher interest rate and the charges offset the savings you would otherwise enjoy. There are also limitations on the new low rates that are frequently ignored by the card holder as well as the problem that many credit card holders fail to stop using the older credit cards. The result again is higher monthly payment that can lead to late payments, a poor credit history and a low credit score.
To minimize the chances of being a victim of too much credit card debt and a low credit score as result of these burdensome payments, minimize or eliminate credit card use. If the funds are not available simply forgo the purchase. The headache of trying to pay off high rate debt is hardly worth the joy of a new TV, dinner out or other immediate consumption items. Low credit scores and poor credit histories start with too much credit card debt that started with just a little credit card debt.
Managing Money and Credit
Learning how to manage money the right way is an important step for individuals to take toward controlling their financial position. Understanding where your money is coming from and where it’s going to, not only helps to manage a household budget but can make sure that an individual’s credit remains good as well as helping to improve credit and credit scores that are already weak.
One of the first steps toward financial control and sound credit management is to calculate your net income. In order to improve credit and hence improve credit scores, the first step has to be knowing all of your sources of income after deductions, like income taxes and 401k, are taken into consideration. This net figure ultimately determines how much money can be spent each month on living expenses and debt repayment.
The next step is to make sure all accounts are current or have current information. Along with gathering and managing all current accounts, balancing the checkbook is a critical component in money management since it provides the information on exactly how much money is currently available to save or spend. Prepare statements on all bills and debt and make sure the checkbook is balanced and up to date.
Create a personal budget is next logical step to managing money and credit. A budget is an important tool to control spending, help manage debt and improve savings. A budget can be a fundamental starting point to help you achieve your financial goals. A budget is also a good way to understand what is important to you. Items of consumption such as new toys and cars and furniture are nice but hardly important to our lives and relationships. Determine what’s important in your life including credit, debt and relationships with a budget.
Once a budget is in place it times to take a close look at credit card debt and minimize the use of credit cards. Always use your credit cards wisely. The credit card rates on outstanding balances add up quickly and buying goods that cannot be paid for with current income is only going to make money management harder and stress levels higher. Credit card debt is an easy trap to fall into. The best way to avoid this trap is to avoid using credit cards altogether.
Now its time to pay down any outstanding debt. For those consumers that have credit card debt or other debts, one of the best approaches is to pay the maximum amount of funds available to the highest interest rate debts first and the minimum on lower interest debts to pay debts faster. Call the credit card companies to make better payment arrangement and lower the interest rate to help solve your debt burden.
Now, establish a savings plan. Try to set up an automatic withdrawal plan for forced savings, contribute to a 401K or deposit a portion of your monthly income into some kind of savings account. Even a small amount will add up when it is deposited monthly.
Review and understand your credit report. Obtain a credit report and become acquainted with your credit history. Annualcreditreport.com is the government mandated web site that lets consumers get access to one credit report from each of the three major credit reporting agencies annually. In order to improve your credit and improve your credit score, it is important to know where it stands presently. Repairing damaged credit can be easier than many people believe. But it does require work and no matter how bad the starting point is, you need to see the credit report and credit history to know where to start.
If the credit report shows late payments, high balances and credit lines, or bankruptcies or other collection activities, this will negatively impact an individual’s ability to get additional credit, housing, insurance and many other services that involve credit. Start now with good money management skills and fix as much of the credit report as possible to increase the credit score and credit profile.
Credit Scores and Credit Limit Changes
Credit scores are influenced and change up and down to a number of attributes found in an individual’s credit report. The FICO credit score is the most common credit score used by lenders. In calculating credit scores, the FICO score is derived by analyzing the data in an individual’s credit report and will change as the credit report data changes.
A number of factors are weighed in a credit report to come up with the credit score. Factors include length of credit, payment history, amounts owed, amount of new credit, types of credit used and other factors.
One of the other factors used to determine the credit score is the amount of available credit in relation to credit outstanding. This is further analyzed by the proportion of credit lines used or the proportion of credit line balances such as credit card balances in relation to the total credit limits on certain types of revolving accounts. The FICO score considers the consumer’s credit limit to evaluate what is referred to as the credit utilization rate or how much available credit is being used at the time the score is calculated. The greater an individual’s credit utilization rate, the greater the risk that person will eventually default on a credit account.
Therefore it is reasonable to find two individuals that have fairly similar credit histories and payment patterns and one of these individuals has incurred a significant amount of credit card debt in relation to their available credit limits, while the other individual has relatively low credit card balances in relation to the available credit and the two scores will be different. The individual with the greater amount of debt relative to available credit is penalized for that position.
The credit utilization rate factor that goes into credit score models is why the common advice on credit card for consumers is to avoid running up one credit card to its maximum limit, rather it is generally believed that to maintain or improve a credit score, the credit card balances should be spread out among different cards and therefore reduce the relative amount of debt to credit limit or credit utilization rate per credit card.
With credit cards companies reducing their credit card exposure by dropping credit card limits on customer accounts, it is possible that these consumers are now finding their credit scores dropping as well. In a recent FICO score study, the company found that that approximately 20 percent of the U.S. population experienced a reduction in total revolving credit between October 2008 and April 2009. In general big reductions in credit limits will work the same as increases in the debt by reducing the amount of available credit and subsequently result in a negative impact on a credit score.
According to data from FICO score, the scores derived assess a lot of data and the effect of a single factor like a credit limit reduction on an individual credit score will depend on what other data is on the credit report and how much the credit card limit or line is reduced.
The key factors that impact the credit score in conjunction with a credit limit reduction, according to the folks at FICO score, include: the amount by which their credit limit is reduced, what actions are taken by the consumers in reaction to the reduced credit limit, such as, late monthly payments, changes in the account balances, or opening a new accounts, as well as any other changes in the individuals credit report after the credit limit is reduced.
The negative impact of the reduced credit limit is therefore substantially mitigated by either positive steps of the consumer such as reducing credit balances or financial missteps such as late payments. A credit limit reduction on a single credit card account won’t necessarily damage someone’s credit history or credit score. The final impact will vary depending on each person’s unique credit profile.
Beware of the Little Things that can Hurt Your Credit Score
Countless articles regarding credit inform consumers about the big events that can have a negative impact on their credit score. But, many consumers fail to realize all the little transactions or little known transactions that may have a fairly significant and harmful influence on their credit score.
We all now the importance of good credit and a good credit score in our society with its wide ranging impact from credit and borrowing to employment to insurance and housing and more. Most consumers are also well aware that the higher their credit score the better. And most consumers are aware or becoming more aware of the basics for keeping their credit score high. What some consumers fail to realize is all the lesser know actions that can really harm a credit score.
The basics on credit and credit score management are covered within this site as well as other sources on credit management. These are the key elements that to avoid in order to maintain a high credit score. They are the actions that can have a clear detrimental affect on your credit report and credit score. The obvious actions include late payments on credit accounts that are in a credit report such as credit card, car loans and mortgages, carrying too much credit card debt and more.
But there a lot of consumers and lending professional who do not know all of the not so obvious factors that can harm a credit score. This list reviews the so not so obvious actions to avoid as well as some actions that involve common sense but, where some consumers are not aware at just how damaging their action really is.
#1. Having credit accounts with balances near their maximum amount available. The percentage of available credit used is a key factor in determining a credit score and having a credit account, even if it is a balance transfer on a credit card to consolidate debt, at or near its total available credit limit will eat up all of the available credit and will lower a credit score.
#2. Short lengths of time between new credit accounts or having multiple credit accounts opened in a short period of time. Even consumers with good credit who open multiple accounts will find their credit score may drop due to opening new accounts in a short period of time.
#3. Having late payments accounts turn into collection accounts that in turn become accounts listed in the public records section of your credit report. Public records like judgements, liens and bankruptcies can have a big, negative impact on a credit score. These types of accounts can have a big impact even when the dollar amount is relatively small.
#4. Having too many store credit cards and too few bank credit card accounts. These accounts have a lower value as they are evaluated by credit scoring models and therefore having more of these accounts and fewer heavier weighted credit accounts can bring a credit score down.
#5. Having no recent credit activity or no recent revolving account activity such as credit card balances and monthly payments. It can actually hurt your score if you pay off your balance in full each month or simply don’t make transactions with credit. Without a monthly payment history, the credit score models have very little data to work with.
#6. Collection accounts and more collection accounts. Collections accounts may rank as one of the more obvious credit score killers, and there are now more types of accounts that are being sent to collection companies that report to credit reporting agencies which will shift a credit score lower. More and more local governments are reporting unpaid parking tickets, library fines and other delinquent fees to collections agencies which may get reported to the credit bureaus and impair a credit score.
#7. Creditors showing delinquent credit records that normally don’t report to credit reporting companies are now reporting in greater numbers. This can be especially true on those customers with a sketchy payment history. The biggest example of this change is the utility companies such as the electric company, gas company, phone company, etc… More utility companies are reporting seriously delinquent accounts as well as customers that are simply 30 days late to the credit reporting agencies which is definitely going to hurt an individuals credit score.
#8. Excessive inquiries. Every time someone looks at an individuals credit report, it is considered as an inquiry and stays with the credit history. Too many inquiries can lower a credit score since it is indication of someone opening more credit and incurring more debt.
And don’t forget more of the basics that will damage a credit score such as having high credit card balances, high balances relative to available credit and late payments.
Simple Myths Regarding Credit Scores
Myths and urban legends abound on the Internet, but most of them can’t impact your finances. However, there are many financial myths that can cost you a lot of money. Myths about credit reporting and your credit score can take a significant amount of your hard-earned money out of your wallet.
Making a lot of money will help your credit report and your credit scores.
It is a common misconception that a big salary will lead to spotless credit, low interest rates and a high credit score when, in fact, your salary has no impact on your credit report or credit score. People with impressive salaries still get hammered with high interest rates and get slapped with decline letters when they let their credit card payments lapse, take on too much debt or engage in other behavior that impacts their credit report.
Your paycheck may not help you get the credit you want, but it is important to lenders. Before lenders loan you money, they want to know that you can make payments well into the future. The ability to make payments many years in advance is called “capacity.”
Your salary is used by lenders to determine your capacity to make regular payments. Lenders use credit reports and credit scores to decide whether to issue you credit. You can have a large salary, but if you have poor credit, it won’t matter to lenders. Money matters, but it’s not all that’s important to obtain a good credit history and credit score.
Paying cash for everything will help your credit rating.
Paying cash for everything fails to establish any type of credit history. Without any credit history, you won’t have a report or a credit score for lenders to evaluate. In order to be deemed credit-worthy, you must open and use a variety of credit accounts. A lack of credit history will result in low credit scores. Good luck getting a loan with low credit scores!
Even if you think that you will never need credit, you will need it! Whether you need a car or a home, your credit report is your golden ticket. Your credit report is checked before you make a major purchase and in some places, before your rent anything from an apartment to a movie. Without some form of credit it is difficult to make online purchases or even to make hotel reservations for hotels and rental cars.
Using credit is an important part of society. Living a cash-only lifestyle isn’t a good thing. Managing your credit, credit profile and credit scores is a good thing.
A great credit score is a result of a credit report WITHOUT any late payments.
Did you know that only 30% of your credit score comes from paying all of your bills on time? You won’t have a great credit score without on-time bill payment, but paying your bills on time is only part of having a great credit report.
The rest of your credit score is made up of things besides our bill payment history. Most people don’t know this. It would come as a surprise to many people who struggle to make monthly minimum payments.
If you want to maintain an excellence credit score, you must not allow yourself to become mired in debt. Paying just the minimum amount each month sends a signal to the credit world that you are barely keeping your head above financial water. Making more than the minimum payments will help improve your credit score.
A divorce decree will absolve you of your credit responsibilities.
Focusing on your joint debts while going through a divorce is one of the most important things you can do. While judges will often decree that one spouse will take responsibility for paying the car note and the other spouse is responsible for the mortgage and credit card bills, the lenders will still honor the terms of joint contracts since the divorce decree does not invalidate or alter the original loan or credit card contract.
Simply stated, if your name is on the contract along with your spouse, the creditors will report any late payment on both credit reports. If your spouse defaults on the loan, you can be held accountable by collection agencies, despite any judge’s ruling and your credit report and credit score will reflect any delinquent payments.
All three of your credit reports and credit scores will be the same.
Nothing can be further from the truth. Your credit reports from the big three agencies will be different, and so will your credit scores.
There are three main reasons for this:
Not all lenders report to all three credit-reporting agencies. Reporting is a voluntary act and most lenders don’t report to all credit agencies.
An inquiry record is left whenever someone checks your report. You will likely have a different number of inquiries on each report since most lenders only pull a single report. The only exception to this is mortgage lenders, which pull all three reports.
Lenders may update their accounts on your reports at different times of the month depending on the credit reporting agency. A lender may report to one agency on the first Monday of the month and the next agency on the third Tuesday.
These reasons make it highly unlikely that your credit score will be identical across all three credit reporting agencies.
If you have poor credit then your credit scores will suffer for seven years.
This common myth is just not true. If you have credit problems, the design of the credit reporting system allows you to start improving your credit score in a matter of months in some cases.
The credit score system calculates your scores daily based on the information in your credit report that day. If you work to immediately improve your credit score by making on-time payments and consolidating debt, your credit score will improve immediately.
If you are about to pay off a large debt or if you have a negative report removed, you will see an instant improvement in your credit score without waiting for seven years.
Check cards can help your credit reports and scores.
Check cards do not help your credit score any more than a checking account can. Check cards just provide paperless access to the cash in your checking account, even though they may be branded with a Visa or Mastercard logo. These logos make it easy to use your debit card where credit is accepted, but they are not credit cards. They can harm your credit, however.
If you don’t carefully record any check card transactions, including any associated fees, it could result in bounced checks and declined transactions. A pattern of bounced checks an poorly managed checking accounts is tracked by companies that may report to credit agencies. Don’t let check cards harm your credit!
Moving your credit card balances around will help you hide your debt from the credit scoring models.
Your credit score is calculated using something called “total revolving debt,” the total amount you owe on your credit cards. Moving your balance from one card to another does nothing to lower or hide your credit card debt from the credit scoring model. If you have 3 cards with $1000 worth of debt or 2 cards with $1500 worth of debt, you still have $3000 worth of revolving credit card debt. It is impossible to hide your credit card debt.
Even if you consolidate all of your debt onto one card, you still have $3000 worth of revolving debt. The only way to remove credit card debt from your credit report is to pay it off!
You can improve your credit score by transferring balances that are near their credit card limit to more than one credit card so that the amount of credit card debt available per card is higher.
Paying off (or “settling”) late payments, tax liens, collections or judgments will remove them from your credit reports.
Paying off your bills and negative accounts is the right thing to do, but it’s not that easy to remove them from your credit report. You can’t make negative reports disappear just by settling your debts.
Many people think that paying off debts somehow cancels out the negative report, but all reports, eve negative accounts that have been paid off, will remain on our credit report for up to seven years. The accounts will be marked to show that the debt has been paid or release, which is better than unpaid debts, but they will still adversely affect your credit score.
Collection agencies take advantage of this myth by promising to remove the item from your credit report if you will pay your account. Don’t fall for this lie. It’s just not true. The only way to remove negative information from your credit report is for the information to be inaccurate.
Credit reporting agencies will never remove an accurate negative account just because the account has been paid in full.
In addition, when a payment is made on an old delinquent account, the date is updated in your credit history and can sometimes negatively impact your credit score. You have to be very careful to review all delinquent debts and evaluate which ones to pay, which ones may be removed due to the statue of limitations and which ones can be settled to your advantage.
Closing credit cards will increase your credit scores.
Of all the credit card myths out there, this one is the biggest. It is the most common piece of advice that people are given as a solution for low credit scores. Not only is it not true, it can actually do a great deal of damage to your credit score.
The reason it can be so damaging is because of a measurement called “revolving utilization’ that credit scoring models use. This is the way that revolving utilization works. If you have 10 credit cards with a credit limit of $1000 each, you have an aggregate credit limit of $10,000. If three of these cards are maxed out, then you have an aggregate credit card balance of $3000. This would give you a revolving utilization of 30% ($3000 divided by $10,000=.30). The seven cards that you are not using keeps your revolving utilization number low.
If you close out those seven unused cards anyway, you will have three maxed out credit cards. This means that your revolving utilization is 100% and your credit scores are now in the basement.
This example may be exaggerated, but no matter how many cards you have or what the limits are, closing unused credit accounts almost always damages your credit scores.
If you have closed your unused credit card accounts you can repair the damage, but they will all have unavoidable negative consequences.
Try to reopen the seven accounts that you just closed. Of course, it won’t be as simple as closing them was. The lenders will pull your credit report, which could lower your score, and with a high revolving utilization number, you may not be able to open all the accounts. It will also show on your credit report that you opened seven new accounts.
Request a credit increase on your remaining cards. Your creditors may deny your request and they will pull your credit report, which will result in new inquiries on your credit report.
These credit myths can be damaging to your credit report and credit score if they acted on without confirmation of the consequences. Repairing a damaged credit history and improving a credit score is not an overwhelming endeavor but it does take knowledge and proper action to achieve the optimal results.