Poor Credit Credit Cards
Some people would say that credit cards are the cause of low credit scores. This is similar to saying that spoons cause obesity. Responsible use of credit cards can be important in the monthly management of the household finances. Training in financial management is essential for anyone who wants to live within the monthly income and reach long-term financial goals.
After financial missteps, the consumer wakes one morning to find that the credit history has scars, and the credit score has dropped. This situation can be rectified with some discipline and active decision-making. Commitment to the goal is important because this course change will require time.
Causes of Low Credit Scores
Three credit bureaus exist in the United States: TransUnion, Equifax & Experian. You can obtain a free credit report from each of them here, but you may need to pay to see your actual scores. Each one maintains separate records for every consumer with a tax identification number. Repairing credit history requires knowledge about the causes of a low credit score.
Job loss – Unemployment causes the income to drop to zero while the monthly bills remain. The consumer is forced to find other means of paying the bills to provide food and shelter.
- Non-existent credit history – Never establishing a credit history can present complications later in life. The individual without a credit history will be considered an unproven risk when applying for credit cards or loans.
- Late payments – On-time bill payments are essential for the person who wishes to maintain a high credit score and access to prime lending instruments. One late payment can deal a severe blow to the credit score.
- Excessive inquiries – Each application for a credit card, or loan, will create an entry against the credit history. Multiple inquiries in one month will indicate to the credit bureaus that the consumer is attempting to obtain credit. Each inquiry lowers the credit score because of the perceived risk.
- High credit card balances – Each credit account on file contains an “available credit” amount. Outstanding credit balances that cause the ratio to exceed 30 percent will weigh on the credit score. High credit card balances are rated as high risks of default for the lender.
- Bankruptcy – A consumer with a bankruptcy on the credit history will endure up to 10 years of being considered an unacceptable risk to creditors. Mortgages, auto loans and credit cards can be acquired in the subprime market while paying higher interest rates and additional fees.
Rebuilding Credit History
Following a series of credit problems, some consumers decide to avoid using credit in any form. This extreme response causes the consumer to disappear from the credit bureau records. On-time payments against active loans or credit accounts will do more to create a positive credit history. The payment history comprises 35 percent of the credit score. Outstanding debts and the debt utilization ratio comprise the rest of the score.
Wise credit card use must be accompanied by careful actions in the following areas:
Credit card applications – One credit card application will not have a negative impact on the credit score. Multiple applications in rapid succession will indicate a potential risk to the lenders. Higher interest rates or denials will be more common if too many applications are outstanding at one time.
- Choose good credit types – An auto loan is a good instrument to demonstrate responsible financial habits. Large credit card balances communicate the inability to restrain spending. The credit score will decrease as the outstanding debts remain over a series of months.
- Close accounts with care – An open credit card account in good standing, but without a balance, has positive effects on the credit score. The debt utilization ratio is healthier when the entire balance of available credit is unused. Length of time the credit accounts exist communicates good relationships with creditors.
Raising Credit Scores
In certain situations, the consumer will want to take fast action to improve the low credit score. Loan applications require a healthy credit score to receive the lowest interest rates available. Employers have started checking the credit score prior to hiring the individual. Landlords can refuse to approve a rental application if the consumer has a low credit score.
Apply these strategies to raise the personal credit score in all three credit bureaus.
Authorized credit card user – A lender will approve an authorized user on a credit card if the individual is related to the account holder. The authorized user does not have a contractual obligation to pay the bill. As payments are made, the positive history is added to the authorized user’s credit report. This type of request must be made of an individual with a clean credit history.
- Reduce utilization rate – Outstanding credit and available credit are used to calculate the credit utilization rate. Credit bureaus prefer that the consumer maintain a utilization rate below 30 percent. Repaying the outstanding balance is one way to lower this percentage. The other method is to raise the available credit amount.
- Correct credit limits – Each year, the consumer is allowed to request a free copy of the entire credit report. Careful investigation reveals that almost half of all Americans have incorrect credit limit information on the credit history. These amounts should be corrected, which can improve the utilization rates.
Reasons to Have a Credit Card
Financial activities can be easier to complete with a personal credit card. The consumer is wise to set personal spending limits prior to using the card for various types of purchases. Careful management of the credit card will provide assistance without causing financial hardship in subsequent months.
Positive credit history – Full payment of the outstanding credit card balance each month demonstrates responsible spending habits to the credit bureaus. The consumer can use the credit card within the established budget limits.
- Convenience – Carrying large amounts of cash is not normal for most people. A credit card supports significant purchases, including monthly grocery purchases. In many places, a personal check is not accepted, so a credit card is required.
- Online purchases – Websites will accept the credit card information as payment for purchases. Wise consumers will refuse to provide a credit card number to anyone who initiates unsolicited contact. Identity theft is possible with the information on a credit card account.
- Travel expenses – Hotels, rental car agencies and airlines prefer credit card payments to make reservations. Travel insurance, card replacement and other helpful services are offered through certain credit card providers.
- Emergency expenses – While away from home, the consumer can encounter vehicle issues, a need for a last minute flight or medical expenses. The credit card provides an immediate payment instrument. An emergency fund should exist to pay the bill upon arrival.
Stop & Think Before Using Your Card
Reaching for the credit card first is an expensive method of meeting financial obligations. The wise consumer will stop and consider many other options prior to using the credit card in most situations. Incurring debt can be avoided if these options are considered.
Use a debit card – Purchases can be made with a debit card. The funds are taken from the checking account in the same way that a personal check would be paid.
- Set a spending limit – A monthly credit card spending plan will prevent the consumer from spending too much money with the credit card. Firm commitment to never exceed the amount is important.
- Consider credit, borrowed money – Any amount of money spent through a credit card is borrowed against future income. This fact must enter the consumer’s mind each time a credit card is used to complete a purchase.
- Understand credit card terms – All credit card providers must send a written copy of all terms associated with the credit card. Additional fees must be explained in writing. Changes to these agreements must be sent to every cardholder prior to taking effect.
- Know personal weaknesses – Each consumer must come to terms with triggers that cause overspending. Preventative measures are the best approach to avoid unnecessary spending with a credit card.
Hidden Costs & Fees
Consumers are wise to understand the fees that lenders charge for the privilege of having a credit card account. Each bank will offer different terms that will match the accountholders personal spending habits. Hidden fees must be revealed in the written documentation that is sent to the cardholder when the account is opened.
These are examples of fees that a credit card company can charge to the consumer:
Cash advance – A credit card that offers a cash advance option has an added measure of convenience. The amount of cash received is added to the credit card balance and incurs interest charges from the day of the withdrawal. Fees are assessed for the convenience of receiving the cash.
- Roll-over interest charges – Any balance that is not paid in full each month will roll over and incur interest charges in the next month. Minimum payments against the balance are expensive for the consumer.
- Maintenance fees – Certain lenders require a monthly fee to maintain the account while the balance is paid. These fees will add to the amount of money required to pay the entire balance.
- Application fee – Few credit card companies charge the applicant to complete the card application.
- Balance exceeds card limit – Banks are allowed to charge $25 to $30 if the cardholder makes a purchase that increases the card balance to more than the agreed upon credit limit. Interest on the card and balance transfers can increase the balance and cause an “over the limit” fee.
- Payment is minutes late – A credit card payment can have a “due time” as well as a “due date.” Last minute payments that arrive on the right day can be charged $25 to $40 for arriving after a 2 p.m. deadline. The written agreement on the account must state this fact.
- Interest rate increase after late payment – A late payment can cause the interest rate to jump dramatically. Introductory, or special, rates can be revoked if the cardholder does not make on-time payments every month.
- “Fixed” interest rate – Marketing terms, such as “fixed interest rate” can have limits that take the cardholder by surprise. The initial interest rate might be 9 percent for 90 days and then jump to 12 percent without notice. These facts are contained in the account documentation.
- Fraud insurance – All cardholders are insured when carrying a Visa, MasterCard or American Express. The account owner does not pay fraudulent charges that are not authorized by the cardholder. Insurance against this risk is unnecessary.
- Balance transfer – Closing high-interest rate credit card accounts will require that the balance on the card is transferred to another card. Fees associated with this convenience can be substantial. The consumer must be aware of the amount of money added to the new balance.
- Conversion fee – Currency conversion fees can be as high as seven percent on each transaction. Paying for expenses in another country with a U.S. credit card could carry some significant fees. These fees can add up quickly and cause the balance to go over the card limit.
- Closure fee – Credit card issuers can charge a fee of $50 to close the account. Prior to using the card, read the fine print to determine if a closure fee will be assessed
- Inactivity charge – A credit card that has not been swiped in six months can incur a charge of $15. The accountholder must be aware of this hidden fee associated with having the account open.
Interest Rates on Credit Cards
Each month, a credit card account with an outstanding balance will incur interest charges that will be added to the balance. Consumers rarely stop to think of the financial drain these charges place on the annual household budget. Hundreds, or even thousands, of dollars each year will be paid on purchases that have been forgotten. The wise consumer refuses to accrue a balance on a credit card that cannot be paid in full in the same month.
Two different categories of lending criteria divide the credit markets into sectors. Recent financial events have caused the prime market to shrink while causing most consumers to fall into the subprime market.
Subprime credit cards – Consumers who must apply for these credit cards must pay security deposits, annual fees, application fees and higher interest rates. Past credit problems indicate a higher risk of default to the lending institution.
- Prime credit cards – High credit scores indicate to the lender that the consumer has a positive record of repaying debts. Lower percentage rates and reward programs are offered to consumers in this category.
- Credit Card Calculator – To learn the actual cost of carrying a credit card balance, the consumer should visit this link and enter the requested information.
Pay More Than the Minimum Payment
In this example, Joseph and Josephina each have a $2,000 balance on a credit card account. The minimum payment must be 3 percent, or $10, whichever is higher. Being strapped for cash, neither person is able to pay off the balance. Josephina adds an additional $10 to her payment each month. Joseph sends the minimum payment.
Both accounts incur an annual interest rate of 20 percent on the outstanding credit balance. The payment sent to the lender is applied to the balance and some of this interest charge.
Joseph’s account has the following amounts associated with his credit card debt:
Principal amount: $2,000
- Monthly interest charge: $33.33 = $2,000 x (1 + 20%/12))
- Monthly minimum payment: $60 = 3 percent of the outstanding balance
- Principal payment: $26.67
- Remaining account balance: $1,973.33 = $2,000 - $26.67)
Each month, these same calculations are conducted until the entire debt is repaid, and the account balance is zero.
After 15 years of paying on this $2,000 debt, Joseph has paid $4,240 in payments. Interest charges total $2,240 through the life of the debt.
On the other hand, Josephina continued to pay an additional $10 every month until the entire balance was repaid. After seven years, she had paid $3,276 to absolve the entire $2,000 credit card debt. Her interest charges were $1,276.
Paying just $10 extra each month saved Josephina almost $1,000 and shortened the repayment period by more than seven years.
Small amounts of money paid in addition to the minimum payment will dramatically reduce the amount of interest paid on any credit card balance. The best choice is to avoid carrying a credit card balance at all.
Available Purchasing Instruments
Consumers should be aware of the various financial instruments that are available. Proper use of each one ensures that the household financial activities will stay within the budget and support future goals.
Checking account – A personal checking account is the basis for the household finances. Writing a personal check to pay a bill is the primary method for meeting monthly obligations. A debit card is a convenient payment method that withdraws month from the check account to complete a payment transaction. Banks offer free checking accounts to those who maintain a positive balance and stay within the account rules. This type of account does not affect the credit score or require a credit check.
- Prepaid debit card – A consumer with poor credit will be required to deposit money with the lender to use the card. A card balance of zero prevents further spending. Prepaid debit cards can be expensive because of the various fees that are charged for using this financial instrument. Use of a prepaid debit card does not raise the credit score since an actual line of credit does not exist. A checking account is a better instrument.
- Secured credit cards – A consumer will post money in this account that is equal to the credit limit. The funds are held as long as the account remains open. Use of the credit card must be within the limit and payments are made to repay the balance on the account. The deposited funds are refunded when the account is closed. Use of a secured credit card is a positive step toward improving the credit score.
- Unsecured credit cards – Standard credit card accounts are the most common type. Collateral is not posted against the account. Lenders have high standards for accountholders because of the risk of nonpayment. Anyone who can qualify for a standard credit card can use one to build the credit history.
Control Impulse Shopping
At some point in life, consumers learn to avoid the situations where money is spent needlessly. Adjustments to certain personal shopping habits can reduce the desire to make unplanned purchases.
Follow these recommendations to prevent misuse of credit cards.
Replace shopping pastimes – Avoid malls and retail stores when a real need does not exist. Retail space is designed to lure the shopper into buying situations. Use of credit cards increases the likelihood of a purchase.
- Shop alone – Control over the budget is easier to maintain when the household manager investigates the best deals and makes a trip alone. A shopping trip with affluent friends can result in expensive purchases that do not fit into the budget. Competition between friends is detrimental to the person who is attempting to rebuild a credit history.
- Avoid commercials – Catchy songs and attractive photos are designed to attract the potential customer’s attention. Use the mute button or switch the radio station when the commercial breaks are running.
- Involve the children – Constraints on the household budget are hard to understand if the answer is always “no.” Ask them to participate in the effort to reduce expenses and reward them with more family time.
- Create a household budget – Families who live by a budget are more likely to reach long-term financial goals, such as college educations, than those who live without a budget. Impulse buying is easier to refuse when the budget does not have any room for splurging.
- Leave the credit cards at home – Studies reveal that consumers will spend 30 percent less every year if spending cash exclusively. Constraint on the spending habits is easier if money is not readily available to spend.
Reasons to Have an Emergency Fund
A household without an emergency fund, which consists of three to six months of income, must incur debt to handle the situations listed here. Multiple incidents can cause long-term financial hardship.
Wise money managers will restrain all future discretionary spending until an emergency fund is built.
Job loss – A healthy savings account relieves the panic if the household income decreases, or disappears. Without any credit card debt, the household will have fewer monthly bills to pay.
- Major medical bills – Anyone without major medical insurance must have a large savings account to cover charges that can arise from an illness or injury. Those with insurance must pay for the deductible, co-payments and charges that are over the usual and customary amounts.
- Large dental bill – As children grow, the need for good dental care increases. Studies show that healthy teeth support health through the later years of life. Orthodontia and wisdom tooth removal is expensive.
- Emergency pet care – Wise pet owners will set aside sufficient funds to pay for an injury or serious illness. Providing the best quality of life for each pet will cost money.
- Car repairs – As vehicles become more sophisticated, the cost to repair the car can add up quickly. Expensive repairs can cause the owner to rack up a large debt if sufficient cash is not saved in advance.
- Home repairs – Significant weather events have become more widespread as the population spreads further. Deductibles must be saved ahead of time to prevent hardship in the face of loss.
- Unexpected taxes – Federal, state and local tax obligations add up fast for anyone who is self-employed. A significant savings account is important to avoid loss of valuable assets in response to an IRS demand for payment.
- Unanticipated travel – Last minute plane travel can be expensive. A death in the family could cost thousands of dollars if the time is short, and the entire family must attend the service. An emergency fund will reduce the stress associated with unexpected loss.
- Funeral costs – A funeral can cost more than $10,000 once the entire affair is over. Life insurance might offset some of that cost, but there are still bills associated with dealing with the loss. Emergency funds are important to relieve the stress that follows the loss of anyone special.
How to Build an Emergency Fund
A dollar amount equivalent to three to six months of income seems daunting to the person who must start an emergency fund. The discipline to start the fund can come from many different creative ideas. Getting started is possible if the household has a budget. Expenditures can be evaluated and eliminated to make room to save some money.
Save the tax refund – A significant start on the emergency fund can be gained through the tax refund. Set up an interest-bearing savings account and ask the IRS and state taxing authorities to deposit the money directly in the account.
- Save money first – Adjust the withholdings on the federal tax withheld to avoid tax refunds next year. The amount of money that is not taken from the paycheck should be directed to the savings account. Designate an additional $10-$25 per paycheck to the savings account through automatic deposit.
- Reduce the bills – Hold a family meeting and decide which services can be eliminated or pruned from the monthly budget. This change does not have to be permanent unless there are extreme services that should be cancelled.
- Find extra cash – Most families have enough extra stuff sitting around to sell. The cash from a garage sale or online classified ads should be saved in the emergency fund.
- Set goals and use rewards – Monthly and yearly milestones should accompany the dollar amount set as the final savings account balance. As each goal is reached, hold a family celebration.
- Make saving fun – Every family member can help with the efforts to prioritize saving over spending. Contributions to the fund should be cause for celebration because the family spending habits are changing.
- Collect spare change – Spending cash generates significant amounts of change. Every person in the family should have a change jar to collect coins throughout the month. On the first of the next month, take the change to the bank and make a deposit in the savings account.
A consumer with a low credit score is a prime target for unscrupulous characters. Savvy consumers will refuse to fall prey to anything that seems too good to be true. Here are some recent examples of scams:
One credit card scam involved an offer to the consumer for an unsecured credit card without a credit check. The consumer just had to pay a $99 fee and provide a copy of the driver’s license. The result is identity theft.
- A card that seemed to be a credit card was redeemable only at the provider’s online mall. The offer included a “free credit report.” The actual account was fraught with fees that had to be paid to avoid more scars on the credit report.
- Another type of credit card imposed an annual fee of $75, which was deducted from the card’s initial $300 credit limit. This scam left the cardholder with a limit of just $225. Annual fees rose sharply after the first year the account was open. Requests to raise the credit limit were met with additional fees.
Spending habits must change to allow the consumer a chance to improve the credit history and score. An emergency fund provides a safety net against incurring debt in response to the events of life. Every consumer is wise to understand that outstanding debts negate the growth of savings and investments. Interest paid on a credit card will erase interest earned on another account. All debts must be considered borrowing against future income.
Happy families can learn to be content with existing cars, houses and belongings. The best blessings in life have nothing to do with the amount of money earned or spent throughout the year.