Credit Card Tips (7/13/2007)

First off, having a credit card is a good and simple way to obtain credit. Be sure to pay your bill on time and, for the most part, you’ll be in good shape when it comes to your credit score. There are a few additional tips I’d like to pass along that may not seem so obvious.

How can credit cards affect my credit score?
Generally speaking, the more available credit you have, the higher your score will be. If Joe has a $2,000 balance on a credit card with a $10,000 limit, he’d have $8,000 of available credit. If Jane had two credit cards, both with a $2,000 balance and both with a $10,000 limit, she’d have $16,000 in available credit. In this scenario, Jane would have the higher credit score since she has more available credit. While opening additional credit cards or increasing the limits of your existing credit cards boosts your score, I don’t recommend this approach. A good financial institution will dig into your credit report and view a high availability of credit as a negative attribute when underwriting a loan, even if your balances are low. Your “ability” to get into a financial hole isn’t a good option to have.

On the other hand, it’s not a good sign if you’re maxing out your credit cards either. If you have only one credit card with a $4,000 balance and a $5,000 limit, this will certainly decrease your credit score. In this case, I’d recommend getting a second card with a modest limit or raising the limit of your existing card to $10,000.

Generally, I’d recommend not using more than half of your allotted credit limit on any card, unless you have an unusually large purchase to make that you plan to pay down quickly. I’d also recommend that you close any credit card accounts that you don’t use. Keeping credit lines open just to prove to yourself that you can purchase a car with the swipe of a piece of plastic is idiotic.

Credit history and depth is important as well for your credit score. Lenders want to see consistent habits over a long period of time. Credit history is kept on your credit report for up to seven years. This doesn’t mean that a minor blip, such as one late payment, will hurt you. Lenders are more concerned with recent credit history. Older mishaps in your credit history are weighted less during the underwriting process.

Balance Transfers
Due to competition within the credit card industry, it’s very common now for consumers to transfer their balances to cards that are providing a low introductory rate. Banks have begun to provide incentives to customers that transfer their balance from another card. While this may save you money in interest charges, this is a bad habit if it continues. This has turned into a game for many consumers and credit card companies usually win. If you decide to play this game, be sure to read the fine print before you transfer any balances to a new card. Many credit card companies won’t honor the low rate if you’ve transferred the balance from another card or if some other compensating factor, such as late payments, show up on your credit report. Remember, these are only “teaser” rates and may not be the real thing.

Keep in mind, if you continue to transfer balances to another card, you may be able to run away from the interest charges, but you’ll never be able to run away from the debt. Don’t let the 0% offers give you a false sense of security.

Individual Store Credit Cards
Almost every major retailer has their own credit card nowadays (even Wal-Mart recently started their own finance division). They typically offer a discounted rate for your immediate purchase if you sign up for their card. Typically, I don’t recommend doing this for a number of reasons. 1. It establishes more credit in your name that may work against you down the road when applying for a real loan. 2. The interest rate on these cards is typically much high than conventional credit cards. There’s nothing these cards can do that a regular Visa or Mastercard can’t, other than the immediate discount on your purchase. Which brings me to my only exception. If you’re making a one-time, large purchase at a department store, and the discount offer is significant, I don’t see any problem with obtaining the credit card to get the discount. However, pay it off quickly and close the credit card once it gets to a zero balance. And, by no means, make a habit of this. Part of your credit score is determined by the number of inquiries to your credit. By taking advantage of these offers frequently, it will lower your credit score.

0% Financing Offers
Just like the credit cards that stores offer, these 0% financing offers have also become very popular. These offers are typically made for big ticket items, such as furniture or electronics and are a great tool for smart consumers. Caution: do not use this offer to afford something you can’t really afford. The odds are good that if you can’t afford it now, you won’t be able to afford it when the offer terminates. And once the offer terminates, the interest rates are typically very high so they can make up for the free money they had been giving you.

The 0% financing offer typically gives you a credit card as well, because they are essentially providing you an open line of credit for your purchase. It’s important to close this line of credit when you pay it off. They don’t automatically close the line when the balance is zero. They want you to continue to use it, of course.

Obviously, these are great offers when purchasing cars. This is essentially free money for a fixed period of time. Be sure to read the entire payment schedule. If you don’t plan on paying off the car loan by the time the 0% financing ends, find out what the interest rate will be for the remaining portion of the amortization schedule.

Late payment consequences
While an occasional late payment won’t damage your credit beyond repair, it’s important to make your payments on time for one very important reason. Buried in the fine print, many credit card companies reserve the right to obtain a copy of your credit report whenever they want. If they discover that you’ve paid late for anything, they reserve the right to raise your rate on their card. That’s right, even if you have immaculate payment history with one credit card, they can raise your rate if you’ve been late on payments to another card. Last I checked, Congress is trying to get rid of this practice.

If you have any questions regarding these tips, or suggestions for future Banker’s Stories, please don’t hesitate to contact me. As always, I keep your questions confidential.