What do you think is better? Having only one credit card that is near it’s credit limit that you pay in full each month or three to five credit cards with low balances that you pay off each month? If you picked the first option, you might be surprised to find out how harmful having a high credit balance actually is to your credit score.
Why would you want MORE credit cards with lower limits?
The proportion of debt that you carry on credit card to your credit limit is called a “utilization rate.” Credit bureaus look at this ratio as a factor in determining your credit score. The lower your utilization rate, the better your score. An ideal utilization rate is anything below 30%. We call this the 30% rule. That means that you only want to have credit balances that make up less than 30% of your actual credit limit. For example if your credit limit is $1000, your credit balance should never exceed $300.
What about if you pay your bills on time each month?
Credit bureaus are looking to see if you live within your means and use this 30% rule as measurement. Paying your bills on time shows you’re responsible for your debt, however it doesn’t reflect your lifestyle choices as well as the 30% rule does. That means you should NEVER let your balance exceed the 30% marker.
What about if you don’t have a preset limit?
In some cases, such as with American Express, you may not have a spending limit. In these situations the credit bureau will take the highest balance you ever had on your credit card use that amount as your default balance. If you’re highest balance was $8,000 that would mean your balance should never exceed $2400.
What should you do if you currently exceed the 30% rule?
The first option is to pay off any debt until your balance is under 30% of your credit limit. If this is not an option for you, you can transfer your debts between cards to keep them under 30%. In addition, you can try asking your credit card company for an increased balance. Just make sure to check they are reporting the new credit balance on your credit report or you may find yourself over the 30% limit.
Lastly, if you have less than 5 credit cards, you can try opening a new credit card to help move the balances around.
Category: Credit Cards
The Retail Store Credit Card Scam
Been hit up lately by sales clerks promising big savings if you apply for a retail store credit card?
Just about every major clothing, electronics, and department store offers a similar promotion: In exchange for applying for a retail store credit card, you will get a discount, coupons, or special offers reserved for cardholders.
But if you apply for a store-specific card, you will most certainly not save money. And you just might hurt your credit score, too.
Never Apply for a Retail Store Credit Card!
Let’s take a look at a typical interaction at a department store. Imagine that you walk to the cashier with your loot in hand—in this case, let’s say you are buying a shirt and a pair of socks for a total of $62.
The cashier immediately makes you an offer.
“Do you want to apply for a retail store credit card? You’ll save 15 percent on today’s purchases.”
Heck yes! you think, gung-ho to save $9.30.
But the cashier isn’t telling you a few pertinent pieces of information. Let’s take a look at two of the critical facts you should know before applying for a store-specific credit card.
Never Apply for a Retail Store Credit Card
Reason #1: You will pay more than you save.
Many stores promote their retail store credit card by offering a one-time discount on same-day purchases. But you will most certainly end up paying more than you saved. The banks and the retail stores promoting these store-specific credit cards are counting on you spending more money so that they can recoup that discount, and then some.
Consider all the ways the banks and the retail stores can make money off you:
1. If you are given a one-time offer to save on today’s purchase, you just might pile a few more items into your shopping card.
2. In the future, you will be more likely to engage in a little “retail therapy” if you have store-specific credit cards in your wallet.
3. You will be sent coupons and special offers that entice you to the store. Ever bought something just to take advantage of a coupon?
4. And, of course, you will pay interest and fees on the credit card.
Suddenly, that $9.30 savings doesn’t seem worth it, does it?
Never Apply for a Retail Store Credit Card
Reason #2: Your credit score might suffer.
I can think of three reasons your credit score might suffer from a store-specific credit card:
1. Keeping these cards active can be tough.
2. You might end up with too many credit cards.
3. You will definitely add a credit inquiry to your credit report.
Let’s start with the first reason: Keeping these cards active.
An important part of learning how to fix credit is to have the right number of credit cards. To earn the highest credit score, you should have between three and five revolving credit cards. And these credit cards should be active.
Credit-scoring bureaus want to know that you can responsibly manage your credit cards. If you let your credit cards go inactive, the bureaus have no idea whether you are able to manage balances and debt. In other words, inactive credit cards do nothing for your credit score.
But keeping a retail store credit card active can be tough. Are you going to buy a lawnmower from Sears each and every month? Are you sure you need a new Gap sweater twelve times a year?
Most likely, you will either keep the card active by making unnecessary purchases (which costs you money), or the card will go inactive. Either way, it’s bad news.
Let’s talk about the second reason a store-specific card might hurt your credit score.
Like I said, the credit-scoring bureaus are the happiest if you have the right number of credit cards. If you do not have at least three credit cards, they don’t have the information they need to make a judgment about whether you are responsible. If you have more than five credit cards, they know that you are in danger of getting in over your head.
Three to five is the sweet spot. So if you are limited to just three to five credit cards, why waste one on a card that will only be accepted by one merchant? You cannot reserve a car using your Banana Republic card, but you can purchase a suit from Banana Republic using a Visa.
Too often, people apply for retail cards each time they are offered a discount. These people must also carry American Express, MasterCard, and Visas for everyday expenses, traveling, and business needs. And they quickly find themselves carrying a lot more than five cards.
Finally, let’s talk about the third reason a retail card could hurt your credit score: credit inquiries. Ten percent of your credit score is based on the number of credit inquiries you have on your credit report in the past year. If you apply for a retail store credit card, your score could drop a few points, and this could cost you a lot of money in interest on future loans and credit cards.
Of course, department stores and banks will never tell you to avoid retail store credit card offers! Be sure to learn more of their secrets by downloading our free ebook: 35 Important Facts the Banks Won’t Tell You About Credit.
Authorized Users—The Secret to Building Your Score Fast!
One of the first pieces of advice I give to people who have suffered severe financial crises and want to learn how to build credit is to become authorized users on credit cards. Authorized users are allowed to use credit cards but have no contractual obligation to pay the bills.
For this reason, a person does not need to have a high credit score to qualify for authorized user status on a credit card. However, the credit card’s history will often be reported on the authorized user’s credit report, so long as the authorized user is related to the account holder.
Becoming an authorized user on a family member’s credit card will quickly raise your credit score (even after bankruptcy or other financial disaster) by allowing you to “borrow” the account holder’s clean credit history.
However, the account holder—fearful that you will rack up huge charges you cannot or will not repay—might be reluctant to add your name to his or her account. Let the account holder know that she or he can be protected.
- First, the account holder should shred the credit card that arrives for you.
- Second, the account holder should never give you the account number, credit card expiration date, or card security code.
In this way, your credit score will increase while still protecting the account holder from any irresponsible behavior on your part.
Authorized users should also protect themselves by choosing the account wisely. Only authorized users who are related to the account holders will see their bad credit scores benefit from this strategy. Therefore, be sure you choose an account holder who is also a relative. Try to choose someone with the same last name and address. Otherwise, the credit-scoring bureaus might not recognize your status as an authorized user, and your credit score might not improve.
To make sure that the credit card company is reporting your status as an authorized user, call them and ask. You can also check your credit report to see if the account is appearing. If not, choose another account holder.
Be sure that you also choose a responsible relative with an account in good standing. If you become an authorized user on an account that becomes delinquent, guess what happens? Your score will drop. As such, be sure to pick an account with a clean history of payments. Be sure, too, that the balance on the card stays low—preferably about 30 percent of the limit. If the balance exceeds 30 percent, or if the account holder makes a late payment, you should immediately remove your name as an authorized user so the negative information does not hurt your credit score.
Authorized users usually see a quick jump in their score. After twelve or eighteen months, you might be able to remove yourself from the account and qualify for loans on your own.
Teaching Children About Credit Cards
With the past 18 months reminding us to be thrifty, many parents are realizing the importance of teaching children about credit cards. In particular, we need to teach children how to build credit by using credit cards wisely and, perhaps more importantly, how to protect their finances from misuse of credit cards.
Though the Credit Card Act of 2009 intended to protect consumers from the credit card industry, the truth is that we should be equally concerned about protecting consumers from themselves! Without proper education, our children risk repeating our mistakes. Indeed, “just charge it” seemed a mantra in the 1990s and early 2000s. Middle-class families ended up paying tens of thousands in interest rate debt.
Leveraging the lessons we learned from the recession, we should all begin teaching children about credit cards so that future generations make wiser choices when it comes to charging debt.
Teaching children about credit cards starts at home by allowing your children to make small, approved purchases with your existing credit cards. I know this sounds crazy, so let me clarify: I do not think you should give your child unlimited access to a credit card with a $20,000 limit. That would be a recipe for disaster.
But how about handing your seven-year-old daughter your credit card when she wants to purchase an $11 toy? Allow her to participate in the process by handing the credit cards to the cashier. Tell her to hold onto a copy of the receipt showing you how much money she owes you. Then have her repay the debt by handing you cash she earns from household chores or an allowance.
And how about older children? Teaching children about credit cards can continue when your children enter their teen years. Hold monthly finance and credit meetings where you review credit card statements, discuss interest rates, and explain how the credit scoring systems works. Consider your own “credit card score,” a term I coined to describe how helpful a person’s use of credit cards is in building his or her credit score.
If your finances (and your utilization rate) can handle it, allow your teenager to make a larger purchase. Then charge interest. If your child fails to make a payment on time, charge a late fee.
Do not, however, get angry or ground your child. When teaching children about credit cards, try to establish a scenario that would happen in real life. The credit card companies would never ground a customer for failing to pay a bill on time. They would, however, call their customers at 8 a.m. to remind them that the bill is due. Feel free to call your teenager’s cell phone at the crack of dawn to remind her that her payment is past due.
In fact, you should embrace a mistake that your child makes while at home. Learning lessons early, when the repercussions are minor, is far better than learning them when the stakes are high.
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