As part of your plan for learning how to build credit, you might wonder if you should start closing credit card accounts. After all, if you have more than five credit cards, you have more than the ideal number.
True, credit scoring systems are happiest if you have no more than five credit cards. But before you make that call to the credit card company, be aware that closing credit card accounts can have a major impact on your credit score. Keep in mind a few basics about owning credit cards.
Fifteen percent of your credit score is derived from the age of your credit accounts, with older credit accounts giving you a better score. This part of your credit score is based on the average age of your accounts. As a result, every time you terminate older accounts, you drive down the average age of your accounts considerably and risk decreasing your credit score.
You should also consider how closing credit card accounts will affect the portion of your credit score that considers your credit card limits and balances. Your “utilization rate” is the ratio of your credit card balance against your credit limit, expressed as a percentage. If you have $800 of debts on a credit card and your available line of credit is $2,000, your utilization rate is 40 percent. Since credit-scoring bureaus reward people who have utilization rates below 30 percent, you should try to always keep your utilization rate under that threshold.
Closing credit card accounts can impact your utilization rate in a couple of ways. First, if you decide to cancel a credit card and transfer the remaining debt to another card, you may cause the utilization rate on the second card to rise sharply, which will cause your credit score to drop. Even worse than transferring a balance is leaving a balance on your card after canceling the account. If you leave a $700 balance on the canceled card, your utilization rate will suffer dramatically since the limit on the card will be $0.
So what is the plan for dealing with a bunch of credit cards? Even FICO agrees that closing credit card accounts is a bad idea. Your best bet is to keep all of them active but pay them off every month. You can even find ways to live debt-free and keep your credit cards active. A steady history of payments will demonstrate to credit-scoring bureaus your ability to manage your accounts and will eventually improve your credit score. Pay special attention to the cards with the highest limits, oldest ages, and best interest rates. Be sure to keep these cards active, maintaining a utilization rate below 30 percent.
A final note: Retail credit cards (those associated with a specific store, such as Bloomingdales) are an exception to the “keep-them-open” rule. Keeping a balance on these cards may be difficult since you probably do not need to buy something from these stores each month. Letting a retail account go inactive may not be the ideal choice, but it should not be a cause for alarm unless it causes your credit score to drop, in which case you might be able to reactivate the card with a simple phone call.
Tag: credit cards
The Truth About Closing Credit Card Accounts
When you’re in over your head or you’ve had a bad experience with something, your natural reaction is pretty much always going to be to steer clear of the cause for some time. With credit, this typically means cutting up credit cards and closing credit accounts. Unfortunately, when it comes to your credit score, this is one of the worst knee-jerk reactions you can have. On the surface, getting rid of your accounts makes a lot of sense. You’re having debt issues, so get rid of the source of the problem and your credit problems will start to disappear. The little known fact is that this can actually make your credit issues even worse.
Let’s look at this a little closer. Fifteen percent of your credit score is derived from the age of your credit cards, with older credit accounts giving you a better score. This part of your credit score is based on the average age of your accounts. As a result, every time you terminate older accounts, you drive down the average age of your accounts considerably and risk decreasing your credit score.
Another factor to consider is your recent credit history. The credit bureaus base their evaluation of your credit worthiness on your account activity. If you close your accounts, there’s no activity for them to evaluate. This can result in a lowered score because they have no current data to determine whether you are a responsible borrower.
In addition to your account activity and age of your credit cards, your credit score is also affected by your overall utilization rate. Your utilization rate is your percentage of debt compared to your credit limit. Credit bureaus reward consumers who keep their utilization rate below 30 percent. If you close an account, there’s a good chance your rate will go up and can directly affect your credit score.
If you are having issues with paying a card, some options you might want to consider include transferring some of the debt evenly across other cards so you keep your utilization rates below 30% on all cards. If you’re not able to do that, start reducing your debt and making your way to the 30% utilization rate by making regular monthly payments. A steady history of payments will demonstrate to credit-scoring bureaus your ability to manage your accounts and will eventually improve your credit score. You’ll want to pay special attention to the oldest accounts with the highest limits and lowest interest rates.
Build Credit: Debunking the Lower Credit Limits Myth
Similar to the belief that no credit equals good credit, having lower limits can actually be extremely harmful to your credit score. To understand how this works you need to understand utilization rates, or what we call the 30% rule. Credit bureaus look to see that you are maintaining less than 30% of your credit limit at all times. If you go over the 30% marker, you are considered to be living above your means and this will be reflected in your credit score.
The problem with lower limit credit cards is that it is far too easy to go over the 30% rule. If you only have a $250 credit limit, you can never have a balance of over $75 without creating a negative reaction to your credit score. In addition, many credit card companies report your credit limit lower erroneously. Meaning you may be right under $75 each month, but your credit limit is being reported at $200 instead, putting you over the 30% limit.
In some cases, when you’re rebuilding your credit you may have to work with these lower balances. This will take careful planning to avoid any issues with errors. However, if you have higher balances, you do not want to ask for your rates to be lowered. You can never have “too much available credit.”
The best way to make sure you don’t go over the 30% rule is to use auto payments. You’ll want to schedule a monthly payment for a bill such as a gym membership or other monthly payment you need to make to be taken directly from your credit card. Then, from your bank account, schedule another auto payment to pay the credit card for the same amount.
This may sound like taking a few extra steps, but it keeps your accounts active and you can control exactly what spending is happening on your cards so you don’t go over the 30% limit.
To learn all all the facts on your credit score, get the book that will walk you through the 7 steps to a 720 credit score.
Bad Credit: Improving Your Credit Score Through Secured Credit Cards
For many people who’ve experienced financial issue getting credit in order to build your credit back up can become a huge issue. If you’re in this situation, don’t worry, there are still a few good options for you. One of these options that we recommend for fixing your bad credit is opening up secured credit card accounts.
What exactly is a secured credit card? A secured credit card is just like a regular credit card, but with one major difference. Your credit limit is secured with a cash deposit that the company will use if you default on your payments. It is important to understand that having a secured credit card does not mean you don’t have to pay your bill every month. These are not pre-paid debit cards where you spend the money that is in the account. They act exactly like regular credit cards where you are charged interest on your balance and late fees if you don’t make your payments every month!
Now, this might seem like a bad deal to the consumer, however, in order to help you build a good credit score your debtor needs to make sure they are covered in case history repeats itself. Here’s a look at exactly how they work:
- You choose a credit limit and make a deposit to secure that credit limit.
- The credit card company will issue you a credit card with that pre-set credit limit.
- You make purchases and payments just like you would with a regular card.
- After you have built a good credit history, you can request that card be converted to an unsecured card and to have your deposit refunded.
Also, if you decide that you do not wish to have that credit card anymore and close the account, the card company will refund your deposit, after any balance owing has been paid of course.
Why should you get a secured card?
There are two main reasons: First, if you don’t qualify for an unsecured card, they are fantastic ways to build your credit score… as long as you get the right card. The second reason you should get a secured credit card is that there are a lot of businesses that will not let you use their services if you do not have a credit card. Most car rental companies, for example, will not rent a car to you if you do not have a major credit card. For them, the fact that you have a credit card means that you are less of a risk when it comes to letting you loose in their car.
A few words about using your card…
There’s more to credit than just having a credit card. In fact, in order to build your credit, you will need to have between three and five credit cards. You’ll also need to make sure your balance never goes over 30% of your credit limit, even if you pay off the entire balance every month. Using just 30% of your credit limit shows the banks that you are responsible with your credit and are able to live within your means.
Build Credit: The 30% Rule – Making Sense of Utilization Rates
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.
Build Credit: Debunking the No Credit Equals Good Credit Myth
Credit is a tricky subject. Everyone thinks they know the right thing to do, and everyone seems to be an expert. The fact is, there are a lot of myths and untruths about the way your credit score is compiled. The biggest and first mistake most people fall for is believing that no or little credit equates to good credit. This couldn’t be further from the truth.
Imagine someone you didn’t know came up to you and asked if they could borrow money from you. They promised they’d pay it back to you in a week. How would you know they were responsible or even ethical enough to return your investment? Now, let’s say a trusted friend you’ve known for years came up to you and asked you for the same favor. Your response would more than likely be quite different than the one you had towards the unknown person.
When you have little or no credit, credit bureaus view you as the stranger asking for money. They have very little information on whether you are a good investment and whether they are likely to see a return. You have to become like the trusted friend and create credit history to have a valued and trusting relationship.
This doesn’t mean go out and apply for multiple credit cards and start taking out loans. While you need to show credit history, you also don’t need to go into debt. To create a good credit score, you need at least three credit cards with balances below 30% of your credit limit and an installment loan.
Now, you may be thinking that credit isn’t really a big of deal and you don’t want to have credit cards and loans because they are a hassle. This way of thinking can hurt you financially more than you know. Your credit score is used to determine a number of things including, believe it or not, your automobile insurance and even your job worthiness.
When it comes to purchasing a house, your interest rate is determined by your credit score. This means you could be paying thousands more for your home because of bad credit decisions. Think about this:
On a $300,000, 30-year fixed rate mortgage, a person with poor credit (below 620) would pay $589 more a month than a borrower with a 720 credit score. That’s $589 a month! Imagine what you could do with an extra $7,068 a year. You could buy a new car, save for your child’s college tuition or with wise investments, double, triple, or even quadruple the money!
The bottom line is, your credit score can either help or hurt you financially. Learning the ins and outs of how to maintain a high credit score will give you a great return on your investment of time and research. It may even help you live the life you dream without overextending yourself.
Do You Make These 3 Credit Card Mistakes?
Credit is a modern convenience that many of us could not live without. It allows us to buy things that are well out of our immediate price range, like a home, a car or even a business. For the average American today, credit is pretty much a necessity.
However, with credit so readily available, and the downward trends of our economy, credit has become a system that is very much abused.
The majority of Americans just don’t understand how to use credit properly and make it work to their benefit. Unfortunately, that sometimes leads to people using credit for things that do nothing, but hurt their credit scores. Like the saying goes, “The road to hell is paved with good intentions.” Not knowing how your credit decisions can affect you could harm your financial standing significantly.
If you have a have a credit card, there are a few things you need to keep in mind to help use it for what it was meant for – improving your credit score.
- Never use your credit card for pulling cash out of the ATM.
Think you need that cash ASAP? Think again. When you use your credit card to take cash out of an ATM, you’re being charged twice. You’re charged once for the ATM fee, and again with the interest on your credit card. In fact, most people don’t realize that credit card cash withdrawals are not eligible for interest-free periods. This means you start getting charged interest from day one. On top of that, you’re likely to get charged a higher interest rate on cash advances than on normal purchases. Your $100 dollar cash advance quickly spirals into a significantly higher amount. If you have any other option, it’s probably best to get the money you need a different way. - Just say NO to retail credit cards.
The lure of saving 10% – 15% off your purchase can be a strong one. How many times have you been offered such a discount on your purchase at a retail store if you apply for their store credit card? Have you ever stopped to think why they are pushing these deals if it’s such a “savings” for you? Let’s break it down.If you are late on a payment or only pay the minimum amount, the interest rate of retail store credit cards can be significantly higher than regular credit cards. Retail stores send you promotions and offers to get you to spend more at their store. Often, you’ll just put it on your card and keep accruing debt. Remember that it hurts your credit if your balance goes over 30% of your credit limit.Lastly, your credit score is determined by active credit. If you get a card at a store that you don’t frequent, you’re not providing good credit history and therefore the credit card becomes a liability. The better option is pass on the offer of “savings” and, if you really need to purchase something on credit, use a non-store-specific card instead. - Don’t incur more debt by using credit cards to pay bills.
When it comes right down to it, paying a bill on your credit card is going to do a lot more to damage your credit than it will to provide the help you seek. The problem is, you’re not actually paying anything. You’re simply transferring the debt from the company the bill is from to your credit card company. That’s not solving any problems. Not only are you not reducing the debt, you’re incurring new debt from the interest on our new balance. You also need to be careful that moving your debt from one place to another doesn’t increase your balance to over 30% of your credit limit. Credit cards should be used to increase credit, but only on things that help build your financial and personal worth – not things that decrease it with added charges.
Build Credit: Using Credit Cards As Tools of Financial Freedom
Credit cards have gotten a bad reputation as more and more people view these cards as vessels for temporary financial freedom. The thought of being able to buy whatever you want even if you don’t have the cash readily available is exhilarating. As times have gotten harder and more and more people are relying on credit to help them through, retail therapy has become a quick emotional fix. Unfortunately, if you don’t know how your spending habits hurt or help your credit, you could be paying for more than a quick dose of endorphins.
While credit cards certainly provide access to splurge on these instincts, that doesn’t mean they are all bad. In fact, it’s actually important to maintain three credit cards in order to improve your credit score. This may sound confusing, but your credit card history is a crucial factor in determining your overall credit score. As with many things, there are some points to watch out for. When using credit cards, you’ll want to keep these tips in consideration:
- Always remember the 30/30 rule. 30 percent of your credit score is based on your outstanding debt, and if your credit balance is more than 30 percent of your credit limit, your score is going to drop. Never exceed 30% of your limit.
- Make sure your credit card companies are reporting your actual credit limit. If they are reporting a lower credit limit, then your calculation for 30% of your credit debt is going to be reported incorrectly, therefore damaging your score.
- Be aware of the credit balance myth. Some people believe that they must keep an ongoing balance on their credit card in order to improve their credit score. This mistaken belief causes some consumers to make unnecessary interest payments. The truth of the matter is that credit bureaus have no way of knowing whether you pay your balance in full or make monthly payments. If you have the financial resources to do so, pay your balance each month. That said, keep your cards active. If you never use your credit card, it will become inactive and stop helping your credit score.
So if you need the credit cards, but credit card debt is also damaging, the question then remains: What exactly should you be spending your money on? How can you use your credit cards to build good credit?
To keep things in perspective, consider the following statement: wealth is creating a state of abundance. If you are using credit cards to pay for something, not only are you paying for the item, but you’re paying extra for the right to “pay later.” So instead of moving forward financially, you’re actually creating more debt. With this in mind, it’s important to examine exactly what you are using your credit cards for. Buying a shirt or even a tank of gas for your car at an inflated rate doesn’t really make any sense when you factor in interest. However, purchasing a book on finances or taking a course that will teach you a skill you can monetize will be well worth the extra interest you incurred.
Therefore, credit cards should be used to increase your quality of life or your wealth, not used as a means to create more debt. The next time you’re about to charge something, consider whether that purchase is going to create a state of abundance or create a state of debt. This type of control will not only help you improve your credit rating, but it will also help you make better long-term financial decisions.
Build Your Credit with Do-It-Yourself Credit Tricks
Okay. You want to build your credit score, but you don’t want to pay a bundle.
Here are a few tricks that will help turn a bad score into a good credit score.
An obvious place to start is with your credit cards.
Here’s a little trick that can really boost your FICO score. (By the way, even though it’s perfectly legal, not one consumer in a thousand knows this technique.)
Most credit cards have a limit: a maximum credit line.
You are allowed to borrow against that credit line up to the maximum amount.
But, you should NOT!
Why not?
Lenders don’t like to make loans to consumers who are constantly “maxing out” their credit cards, because they consider them spendthrifts.
In fact, if the balance on any one of your credit cards is more than 30 percent of the credit line, your FICO score will be penalized.
So how do you reverse that trend … and raise your FICO score?
Here are two easy methods that work and won’t cost you a dime:
- Transfer balances from one credit card to another, so that none of the balances exceed 30 percent of the credit limit. If necessary, obtain another credit card and transfer some of your balances to it. (But keep in mind that you should never have more than five credit cards, and that you should transfer your balance after you have secured the credit card and know the limit.)
- Ask the credit card companies to increase your credit limit so that your current balance falls under 30 percent. If you can get the credit card company to raise your limit from $10,000 to $25,000, then you can safely borrow up to $7,499 – and not just $3,000 – on it without jeopardizing your credit.
Now here’s another trick …
You probably don’t know this, but credit card companies routinely under-report the limits on their customers’ credit cards – or, even worse, don’t report them at all. Let’s say your true limit is $10,000. The credit card company might report your limit as only $5,000 to the credit bureaus .
So if you have a $4900 balance, you appear to be “maxing out” the credit card, which will hurt your score.
Why do credit card companies do this? Because it keeps their competitors from offering you other cards.
When competing credit card companies see high limits from another card issuer, they have found credit-worthy borrowers whom they can solicit through the mail.
On the other hand, customers with low limits are not as desirable.
So many credit card companies report incorrect limits just to protect their customer base. But this could be hurting your credit score by causing the bureaus to think you are closer to maxing out your cards.
So what should you do? Simple: Just check your credit report to make sure the bureaus have the correct information. If not, call your credit card company and tell them they must correct the mistake – knowingly reporting incorrect limits is illegal. If you raise heck, the credit card companies will report the correct information.
– Philip Tirone
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