Your Secret Weapon.

A Secret Weapon For Your Credit Score.

 

When you read the words, secret weapon, what did you think of? Are you picturing life or death, drastic measures utilized only as a last resort? Are you envisioning an atomic bomb that the government has been stashing for an emergency response that will unleash lethal doom upon an entire country? Perhaps some type of super soldier that was genetically mutated for destruction in an underground lab? If any of these scenarios came to mind, you need to calm the hell down and lower your thrill expectations for this article before you continue reading. This is about CREDIT, after all. So pop a caffeine tablet and keep up! I'm not here to reveal a literal secret weapon to use against the evil credit bureaus. I'm here to point out the metaphorical secret weapon that may already be in your wallet! Almost, sort of, just as exciting!

That's right! Credit cards! Who would have thought, right? As a credit adviser, the most common misconception I see is that credit cards are of the devil. They have such a bad reputation when it comes to finances and credit. Why is that? Let's take a look into the mind of a 'creditcardaphobic' . . .

I imagine the trauma would read something like this:

Joe is having some financial difficulties, so he applies for a credit card with a limit of $1,000.00. Because his credit score is 800 points, he's approved!

Wow, Joe looks excited. Poor, naive Joe.

Joe maxes out the card, maybe even spends more than the limit and accrues some overdraft fees. He's running low on money again, so he misses a couple payments. Eventually, the financial burden is too much to handle and he can't pay it off at all. After the bank is tired of trying to collect from Joe, they file the amount that he owes them as a tax write-off and sells the account to a collection agency. The agency hassles Joe by phone and written mail and finally agrees to accept his settlement offer (when he pays less than the amount they are trying to collect) and that's the end of it. After Joe pays the settlement, his credit score has plummeted to 550 points. That one credit card has drastically affected Joe's credit rating and in turn, his life. How? Why are the effects so much heavier than every other line of credit?

I'll tell you why, but first you must know how your score is calculated. Your credit profile is divided into 5 categories in order to calculate your score. It's crucial to monitor and care for each category in order to obtain the highest score possible. Those categories are:

Think of school. You take multiple classes, earn a grade in each class, and your grade point average (or GPA) is generated. Same basic concept. The reason credit cards can make such a drastic difference in your credit score is because each card impacts every single category. Monthly.

Let's start with the first and most important category: Payment History. This “class” makes up 35% of your credit rating. When Joe started missing his monthly payments, his “grade” in Payment History decreased. Not only did it affect the category, but each late payment left a negative mark on his credit reports, resulting in a score drop each time another was applied. Those negative marks are considered delinquencies and each one can remain on his reports for up to 7 years from the date he was reported as late.

Moving on to the second most important category, Amounts Owed, which makes up 30% of your credit score and is based around two words: utilization ratios. I will probably mention or stress the importance of utilization ratios in every post. Learn them, live them, love them. Your utilization ratios are how much you owe on a credit card compared to it's overall limit. Bottom line is if you're spending more than 50% of your credit card limit, then you're harming your score. Most banks, credit unions, and credit card companies report to the bureaus on the same day every month. For every month that Joe was spending more than 50% of his limit, the credit bureaus knew it, and his score began to drop. Quickly.

The third category is Credit Length and it makes up 15% of your credit score. This one is pretty self explanatory. This category analyzes how long your credit accounts have been open. The longer an account is open, the better it is for your score. When Joe opened a new account, the card began to affect this category positively. When Joe couldn't maintain the card and the account was closed, not only did his credit length stop growing, but his score took a big hit just for closing out an account.

New Credit makes up 10% of your score. This category is impacted by the number of times you apply for credit. Each time you apply, whether you're approved or denied, a “hard inquiry” is placed on at least one of your reports. You probably know that each hard inquiry takes a couple points off of your credit rating, but if you're approved, those points can easily be recovered with the line of credit that is now helping you're score if you use it responsibly. When Joe applied for a credit card, the inquiry hurt his score. Instead of making up for the lost points, he abused the credit card and his score only continued to decrease.

Last and definitely least, is Credit Mix, which contributes to 10% of the score. While this category impacts credit scoring relatively less than other factors, it remains one piece of the puzzle that shouldn't be overlooked. Your grade in this category is based on your mix of credit, surprisingly enough. Different lenders and bureaus like to see that you're knowledgeable in different areas of the credit industry. Having a mix of revolving and installment accounts will help build your credit score. When Joe closed his only credit account, he removed the only contribution to this “class” and earned himself a failing grade.

As you can see, Joe's bad experience with his credit card affected each category, but the consequences didn't end there! When Joe's bank filed the amount that he owed as a tax write-off, a “charge off” was applied to his credit reports. A charge off is considered a delinquency or a negative item – like a late payment – that hurts the score when it is applied. Each delinquency may remain on the reports for up to 7 years! After the bank applied a charge off, they sold it to a collection agency. Can you guess what happened then? That's right. Another negative item. When the agency purchased the account, a “collection” was applied to his reports. What happened next!? Joe paid a settlement. When the agency collected the settlement offer, another negative item was applied to his reports listed as a “settlement” IN ADDITION TO the collection. With each negative item, Joe's credit score took a major hit. Depending on the way the bank reported the late payments, how many payments he missed, and how long the account was open and unpaid, his reports could now be tainted with:

• 30 Day Late Payment
• 60 Day Late Payment
• 90 Day Late Payment
• 120+ Day Late Payment
• Charge Off
• Collection
• Settlement

All because of one single credit card.

A credit card, if used irresponsibly, will affect every category that you're scores are based on and obliterate your over-all credit history. The ramifications can be life changing. Not only did Joe accumulate debt in overdraft fees, interest rates, and collection fees, but he also ruined his credit rating. His chances of being approved for another line of credit are slim to none and if he is approved, his interest rates will be outrageous.

How do you prevent the worst from happening? If a credit card can negatively impact all 5 categories that your credit score is based on, that means it can also have a positive effect on those 5 categories. How do you take this weapon of mass destruction and use it to your advantage? The answer is easy. Do not get a credit card if you need money NOW. That type of thinking will often result in a situation like Joe's. Apply for a credit card with the overall goal of building your credit history. It will become your credit score's best attribute and most lethal weapon!

Once the credit card is in hand, don't get crazy! When I received my first credit card, I had to keep reminding myself that even though I suddenly had $1,000.00 at my disposal, it wasn't really my money. I was borrowing it. I would have to pay it back with interest. To keep myself in check, I had to set strict rules and guidelines. If you abide by these rules too, your credit card will grow a healthy relationship with your credit score, and they will become the best of friends!

• If you must use the card, never spend more than you can pay back within a timely manner.
• Never exceed 50% of the overall limit. Period.
• Never, ever, ever miss a payment! Automatic payments are there for a reason! Take advantage of them!
• Don't close the account, even if you don't need it anymore. It's there to help you!
• Think of the credit card as a tool to build your credit score, not as extra money to use at your disposal.

A credit card used correctly is the fastest and most affective way to raise your score and build an impressive credit profile. What are the benefits of an impressive credit profile? You'll be approved for just about anything, whether it's a mortgage loan, car loans, a promotion, (yes, some jobs consider your credit for different promotions) student loans, loans for your children, and so much more. You need not fear the card! You shouldn't avoid the card at all costs. Take advantage of this tool! One single credit card could change your life for the better. Just think of what multiple credit cards could do . . . .