Sometimes, I hear from people who are drowning in debt. They just don’t know what to do to get themselves out of their financial holes…
One of my readers, John, recently left such a comment on my blog, and I wanted to take this opportunity to answer it. Here is a summary of his comment:
I recently filed bankruptcy, and I know I need to open three new credit cards, but I cannot get the secured cards that you recommend because I have no extra money. Please help me. I’m drowning.
Okay, I have several pieces of advice…
First, if you have been through a bankruptcy, it is important to open three new credit cards after the bankruptcy has been discharged.
I recommend secured cards, which require you to pay a deposit. But if secured cards are not an option, then I recommend becoming an authorized user on someone else’s credit cards (in good standing).
If neither of these options are available, then and only then should you apply for subprime credit cards.
I dislike subprime credit cards because they usually come with high fees and high interest rates. You can’t do anything about the high fee charged to you upfront (or annually), but you can avoid the interest by charging only small amounts on your credit card to keep it active, and then paying the balance in full.
That said, I have another concern about John’s message: “Please help me. I’m drowning …”
This is my advice: Do not use credit cards as a method of paying for day-to-day life, especially post bankruptcy, unless you have a long-term budget that shows you can repay the debt.
If your budget does not prove that you can repay the credit card debt you plan on incurring to pay off your other bills, you will find yourself even deeper underwater in the months and years to come.
Yes, credit cards are a great tool for getting yourself out of a financial jam, but only when you know you have the means to pay your bills down the road.
You must—must, must, must—create a budget, take a hard look at your finances, and know exactly and when you can pay off those credit cards.
Sincerely,
Philip X. Tirone
P.S. As always, leave your comments and concerns below!
Author: Philip Tirone
10-Minute Pocket Guide to Build Credit: A Free Report
Want a crash-course in how to build credit? Then review this “10-Minute Pocket Guide” every six months or so. I know it’s not really small enough to fit in your pocket … I call it a pocket guide because it’s short. In 10 minutes or less, you can be reminded how to build a 720 credit score.
Step 1: Keep your credit card balances under 30 percent of your credit limit.
To increase or maintain your credit score, your balance on any one credit card should be no more than 30 percent of your limit. For instance, if you have a $10,000 spending limit on your Visa card, keep your balance at no more than $3,000, even if you pay your credit cards in full each month. The debt you carry on a credit card in proportion to your balance is called a “utilization rate,” and credit bureaus respond more favorably if your utilization rate is low.
If your utilization rate is too high, do one or more of the following:
1. Transfer funds among your credit cards so that each card has a 30 percent balance or less; and/or
2. Pay off any debts that put your balance above 30 percent of the limit; and/or
3. Ask your credit card company to increase your limit so that your balance is less than 30 percent; and/or
4. Open another credit card account and transfer balances accordingly (but only after reading STEP 2).
Step 2: Have at least three revolving credit lines.
Credit bureaus give higher scores to people with at least three revolving credit card accounts, which include major credit cards such as Visa, MasterCard, American Express, and Discover. If you do not have at least three active credit cards, you should open some.
If you have poor credit, you might not be able to open a typical credit card. In this case, consider opening a secured credit card. Lenders that offer secured credit cards will require you to make a deposit that is equal to or more than your limit, thereby guaranteeing the bank that you will repay the loan. If you do not make your monthly payment, the deposit is applied toward your balance.
Another option for borrowers with poor credit is to be added as an authorized user to an existing account in good standing.
If you have more than five credit card accounts, do not close the accounts. Most credit experts agree that once you have opened the excess accounts, the damage is done. In fact, closing them might hurt your score and will never help it.
Step 3: Verify the accuracy of your reported credit limits.
Credit card companies often fail to report your credit limit, or they report a lower limit than you have. This causes your utilization rate to be reported as higher than it actually is, which degrades your credit score.
Why do credit card companies fail to report correct credit limits? They do not want to lose their client base. If other companies see that you have a high limit and a positive credit score, they might solicit your business. By failing to report the correct credit limit, credit card companies keep your name off mailing lists and better retain your business.
If your credit limit is not listed on your credit report, or if it is inaccurate, contact your credit card company and ask it to correct the mistake. Follow up with the credit card company by sending a letter. If you are still having problems getting the proper limit reported, contact the credit bureaus directly, send copies of your statements, and ask that they make the proper corrections.
Step 4: Have at least one helpful active or paid installment loan on your credit report.
Having a healthy mix of credit is a great way to increase your credit score. Therefore, to maximize your credit score you should have at least one installment loan, a mortgage, and three major revolving credit cards (Visa, MasterCard, American Express, or Discover). Typically, an installment loan is used to purchase a car, but it also can be used to purchase a computer, furniture, or major household appliances.
Make your installment payments on time. As helpful as an installment loan can be to your credit rating, it can be equally harmful if not paid on time.
Beware of harmful installment loans—those that delay payment on an item for more than 30 days. This type of credit will always hurt and never help your credit score.
Step 5: Remove high-priority errors from your credit report.
An error can be as simple as having the wrong address or name listed on an account. It can be a limit that is not listed. It could be investments you did not make or accounts you do not own. People with accounts in collection often have duplicate collection notices reported for the same account.
Errors come in two forms: high priority and low priority. By removing high-priority erroneous information from your report, you could see your score jump 20, 50, or even 100 points!
Beware, however, of spending too much time on this step. Errors that are older than two years are likely not hurting your credit score that much. As well, do not waste your time correcting low-priority errors. Faster, more efficient ways to increase your credit score are described in the other six steps.
| High-Priority Errors | Low-Priority Errors |
| Active collection accounts less than two years old and listed more than once | Incorrect address of a mistake in your address (low priority, unless you think you might be a victim of identity fraud or a victim of merged credit reports) |
| Someone else’s Social Security number or a mistake in your Social Security number (this could indicate that you are a victim of identity fraud, or this could result in your credit report being merged with another person’s report) | Wrong date of birth (low priority, unless you think you might be a victim of identity fraud) |
| Someone else’s name or a mistake in your name (this could indicate that you are a victim of identity fraud, or this could result in your credit report being merged with another person’s report) | Other incorrect information, such as your employer |
| Accounts that do not belong to you | Typos in your account numbers (low priority, unless you think you might be a victim of identity fraud) |
| Mistakes in your payment history that occurred within the past two years | Mistakes in your payment history that occurred more than two years ago |
| Accounts in good standing that are not listed in your credit report | Delinquencies older than seven years |
| Incorrect credit limits | |
| Collection notices that are not yours | |
| Account information—other than duplicate collection notices—listed more than once (high priority if the account is harming your credit; low priority if it is helping your credit | |
Step 6: Negotiate before paying a bill in collection.
Paying off a credit card after it has been in collection might further damage your credit. Bills that have been turned over for collection affect your score only minimally after two years and are all but erased after four years. Collection notices do remain on your credit report, but they affect your credit score only slightly. However, each time you make a payment on a bill in collection, your credit score will be damaged, and it will extend the amount of time the item stays on your credit report.
If you have a bill that has been in collection, you should not pay it until you get an agreement from the creditor or collection company to submit a letter of deletion to the credit bureaus asking that the derogatory item be wiped from your credit report. When negotiating for this letter, you should never admit that the debt belongs to you.
Step 7: Create a structured plan to protect your credit.
Your credit report changes daily. Once you have started to build good credit, you will need a plan for maintaining it. Otherwise, your good credit can turn into bad credit before you can say FICO. Once you have completed STEP 1 through STEP 6, develop a plan to maintain your credit, as described below.
Create a budget and spend frugally. Make sure you are never late on payments and that you can keep your utilization rate below 30 percent.
Use technology to keep your bills current. Set up automatic payments on all bills that you pay regularly. This way, you will never forget to pay these bills, and your credit will be protected.
Review your credit card bills and bank statements monthly. Check the limit and interest rate and adjust your balance accordingly. Review your credit card and bank statements and compare against purchases you’ve made. If you notice any unfamiliar items on your credit card statement or bank statement, immediately contact the credit card company or bank to determine whether you have been a victim of identity fraud.
Pull your credit report regularly and review the POCKET GUIDE. Contrary to popular belief, if you request your own credit report, you will not hurt your credit score, so request it freely. In fact, the worse your credit, the more often you should pull your credit report. After receiving your credit report, review the POCKET GUIDE and modify your plan accordingly. Make sure that no new derogatory information has been added to your credit report. Also make sure that previously corrected errors on your credit report have not resurfaced. Check for any indications that you have been a victim of identity fraud. For instance, look for names, Social Security numbers, and accounts that are not yours.
Part I: What does a credit score mean?
I spend a lot of time talking about the importance of building a good credit score, but a lot of people want to know: What does a credit score mean?
In this blog post, I’m going to answer that question, taking a look at two factors:
- What does a credit score mean to a lender?
- What does a credit score mean in terms of monthly payments?
What does a credit score mean to a lender?
A credit score is designed to give creditors an answer to one question: “What is the likelihood that this borrower will be more than three months late on a payment within the next two years?”
A credit score generally ranges from 300 to 850. A borrower with an 850 credit score (a rarity) is considered the least likely to default on payments while a borrower with a 300 credit score is considered the most likely to default.
A credit score above 720 is considered wonderful. These borrowers will qualify for the best loans and interest rates. Anything below 660 is considered weak credit, and anything below 620 is considered bad credit. A borrower with a score below 620 is considered “subprime,” which tells the lender that the borrower is highly likely to default.
A person’s credit score is the single most important factor in determining whether lenders will approve your credit card application, mortgage loan, and car loan. Generally speaking, lenders look at four things when determining your creditworthiness:
- Your credit score.
- Your salary.
- Your savings.
- Your down payment (for a home or car loan).
A person with a high credit score and a modest salary would be much more likely to receive a loan than a person with a modest credit score and a high salary.
What does a credit score mean in terms of monthly payments?
We always say that on a $300,000 30-year, fixed-rate home loan, the difference between a 720 credit score and a 620 credit score is $589 a month, or $212,040 over the life of the 30-year loan. Though this statistic is certainly an accurate representation of the difference a great credit score makes, the truth is that interest rates change daily. During the peak of the credit crisis, a person with a 719 credit score (normally considered a great score!) didn’t even qualify for credit.
The interest rates on a loan are updated daily in tandem with the Federal Reserve’s adjustments. As well, different types of loans call for different interest rates.
According to MyFICO.com’s August 2 listing of interest rates, a person with the best credit score would pay $753 a month on a three-year $25,000 car loan; a person with a 620 credit score would pay $919, a difference of $166 a month or almost $6,000 over the life of the loan.
As you can see, if you want to qualify for a loan and receive the lowest payments, you should learn how to improve your credit score.
And next week, we will take a look at several other reasons to build credit in Part II: What does a credit score mean?
This is terrifying
Holy cow. I just read an article that reminded me to be terrified …
If you have a 780 credit score, and you make one late payment, your score could plummet as much as 110 points.
That’s right—your score could drop from 780 to 670 in just a month. That could cause your interest rates to shoot through the roof.
Worse, it could cause you to pay a ton in interest payments.
So this week, I want to focus on the nitty-gritty…
I know that administrative housecleaning isn’t fun for anyone, but you cannot afford to put it off.
Take an hour this weekend to get your bill-paying mechanisms in order. Sign up for auto pay, make sure you know when your credit cards are due, and just make sure that you have a system that protects your credit score.
It might sound simple, but forgetting to pay one bill could be devastating.
Of course, even if you have the best systems in place, money might be tight one month. If you do need to pay a bill late, here are a few things to keep in mind:
- Your utility payments are not included in your credit score unless your account is sent to collections. If you have to make a choice between paying a credit card late or a phone bill late, pay the credit card on time and pay the phone bill late. This will keep your credit score intact.
- Most credit card companies do not report a bill as “late” unless it is past due by more than one billing cycle, which is usually about 30 days. So if your credit card is due August 5, it probably will not be reported as late if you pay it before September 4. Of course, you’ll still have to pay a late fee, but at least your credit score won’t be hurt!
- And finally, if you cannot pay a bill on time, don’t hide from the creditor. Just call them up and say, “I’m having a tough month. Could you give me a 60-day grace period to make some adjustments to my finances?” They might say no, but if you have been a great customer, they will probably say yes!
That’s it for this week’s blog. It’s short and sweet, but you have some homework …
Buckle down and spend an hour on the “nitty-gritty” by making sure you have a system in place so you pay your bills on time each month.
And if you have an innovate system for keeping your finances organized, I’d love to hear it. Leave a comment below.
Philip Tirone
P.S. I’m serious. I really want you to share your ideas below. I’m committed to building a financially savvy community, and we need your help in spreading ideas!
Here’s what I do to keep my finances organized:
- First, I make use of technology to pay all my bills. This means that I have “auto pays” set up for every bill, which includes utilities, credit cards, rent, car payments, and the like.
- Then, I have automatic reminders to review my statements on the 1st and the 15th of every month.
- I put all my “bills to pay” mail into a folder, and I review them every other week. I know this might seem simple, but before I implemented this easy step, I had envelopes scattered everywhere—my car, the kitchen table, and my desk. It made it tough to stay on top of the administrative stuff.
