Using Credit Wisely

Credit is something almost all American adults use.  It can be credit cards, car loans, student loans, and typically the granddaddy of them all - mortgage loans.  Using credit, in and of itself, is neither good nor bad.  How you use it can be good or bad.  It’s rare someone can pay cash for their home- so a loan may be the only option.  Student loans that lead to improved earnings prospects can be good, too.  Buying disposable things (clothes, home furnishings, etc.) on credit for which you can’t pay off - is probably not good.
 
The other thing about credit- and using credit- that we sometimes don’t think about is that our behavior with it tells something about us.  You better believe that the credit issuers are tracking our behavior.  The most common reminders of this are our credit report and credit score.  How good or bad, these are can definitely impact whether we get credit and how much we pay for it (interest rates).
 
Here are some suggestions for managing your use of credit.  Some may help your credit score, while others are just good habits.
 
Utilization rate.  This can have a significant impact on your credit score.  Put simply, how much of your available credit are you using?  The higher the percentage, the more the lender worries.  For example:  You have (3) credit cards with limits of $1,000, $2,000, and $3,000 respectively.  So you have $6,000 of available credit.  Let’s say your best friend has exactly the same set-up.  You have balances of $600, $800, and $1,600 on your cards. Your friend has $700, $400 and $900 on his.  So you have $3,000 in charges or 50% of your available credit.  Your friend has $2,000 in charges or 33% of his limit. To a lender, your friend may look better.  He’s using less of his available credit.  So be cognizant of this, especially if you’re applying for a mortgage.  Don’t go out and charge a lot of things during that process, since it may hurt your score.
 
History.  History can be good, and if it’s good and repeats itself, that can be even better.  Lenders love to see a long history of on-time payments and judicious use of credit (keeping that utilization rate in check).  This “history” comes from your credit report.  The longer you’ve had a credit card, made on-time payments, and paid off balances, the better you look.  Of course, bad habits make lenders hesitate to lend to you or make you pay more for it.
 
Minimum payments.  Every credit card statement comes with a number right near the due date- the “minimum payment”.  This is what you have to pay that month to stay in good standing.  It can be a very appealing number- much less than what you actually owe.  But it’s a minimum, and won’t make much of a dent in the balance you owe.  Most of it will just cover interest charges.  If you pay only the minimum each month it will take years, if not decades, to pay off the balance.  The interest charges you’ll incur will likely be far more than what you actually borrowed. Minimum payments are not your friend and should be avoided as much as possible.
 
Penalty rates, cash advances, overdrafts.  Three expensive concepts you should avoid.
o   Penalty rates:  For most credit cards you actually have several interest rates.  One is the rate you pay on purchases that you don’t pay off each month.  Another is the penalty rate.  For many cards if you make late payments twice in a 12 month period, they may invoke your penalty rate.  You might go from 13% to 26% from one statement to the next.  And you’re stuck with that rate for a while until you can once again show you can pay on time.  If you realize your payment will be late (we all forget sometime), immediately call customer service.  Often the payment isn’t declared late for a few days, and you can square it away before then.
o   Cash advances:  You’re out, need cash, so you stick your card in a machine. Ever look at the interest rate? Most  times, it’s definitely higher than your purchase rate.  It’s cheaper to plan ahead.
o   Overdrafts:  Credit limit?  What credit limit?  Sometimes stuff happens, and we run up against our credit limit without realizing it.  Most times the card has an overdraft protection feature, and they don’t decline it.  But they might charge your interest on it.  By the way- this would be a utilization rate of 100% or more.
 
Most folks try to manage their credit responsibly.  Sometimes though, in an effort to be “good,” they do things that inadvertently hurt their credit history and score.  It doesn’t make sense- until you try to look at it from the lender’s perspective.
 
Stop using a card.  It sounds smart doesn’t it?  Don’t use it, and it can’t hurt you.  Except if you go too long without using it, it’ll appear dormant- and it won’t help your history.  If you have a card- use it at least once or twice a year to keep an active history going.
 
Cancel cards you aren’t using.  People do this for several reasons, including cutting down their available credit.  This sounds smart- less credit means less chance of getting in trouble.  But it has two potentially negative results:
o   If it’s a card you’ve had a long time, and you’ve paid on time all those years, it has a great long-term payment history which helps you.  Close the account, and you lessen the impact of that history.
o   It may increase your utilization rate.  In the example above, if you paid off the second card ($2,000 limit) and closed it, your utilization rate would climb from 50% to 55% ($2,200 owed with $4,000 limit). 
Chasing zero-rate cards.  In an effort to avoid paying interest, some folks search regularly for cards offering no-interest balance-transfers for a period of time.  They keep moving their balances to new cards before the interest charges kick in.  The companies know what you’re doing- and eventually the next one in line is going to decide to decline your application since they know you aren’t going to stay with them.  Your credit report will be littered with all these short-term cards that you don’t use any more.  It’s better to just not charge things to cards when you can’t afford to pay off in full when the bill comes.
 
The best uses for credit:
 
Convenience:  Charge something that you have the money to buy now so you don’t have to carry cash or write checks- and have 30 days to pay.
 
For the perks:  Some folks get points based on spending that they can use for travel or other purchases- so they charge everything to the card.  BUT- they should pay the card off each month.
     
For long-term, appreciating assets:  A home, an education, and maybe a car so you have transportation to work, etc.  As for a car- everyone should aim to reach a point in life where they can pay cash for the car they’re buying.  Cars do nothing but depreciate.
 
Credit can be a great thing- if used responsibly.  Keep these tips in mind when you’re using yours, and over time you’ll benefit from your good habits. 

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