Consumer credit makes buying the stuff we want and need easy and convenient. Credit can also bail us out of a jam, especially if our emergency funds aren't quite up to the task. Unfortunately, that convenience comes at a price. Aside from uncontrolled, in-the-moment spending, credit card use opens us to a variety of dangerous financial mistakes, some with long-term effects.
You probably already understand the dangers of running up those credit card balances, but here are few more dangerous mistakes you may be making, plus some tips on how to avoid them.
1. You only pay the minimum due. Banks use several formulas to calculate the minimum amount due each month. Most start with a percent or two of the outstanding balance and then add in any fees for late payments, exceeding the credit limit, and monthly interest charges. However it's calculated, simply paying the minimum will result in lots and lots of interest payments over time.
You can find out how your credit card issuer calculates the minimum payment by visiting your issuer's website. Your bank's site may also include a calculator that shows you how long you'll owe -- and how much interest you'll pay -- if you merely pay the minimum. If not, try this credit card debt calculator.
2. You pay late. According to FICO, which generates credit scores, payment history is the largest component of a credit score -- 35 percent of the score, in fact. This makes sense because lenders want to know how promptly borrowers have paid in the past, and nobody likes getting paid late. Late payments mean a lower credit score.
There's a second danger here as well. Late payments will result in late payment fees from your bank, which not only cost you a bit more (or a lot more, depending on your agreement) but may also boost your monthly minimum (again, depending on your agreement).
3. Your utilization ratio is too high. After payment history, FICO looks at the "amount owed," which makes up 30 percent of a credit score. The key calculation here is the borrower's credit utilization ratio, which is how much available credit you use. For example, if you have a card with a $5,000 credit limit and a $2,500 balance, your utilization ratio is 50 percent. In generating the score, FICO analyzes each account and the total of all your accounts.
A high utilization ratio can harm your credit score, which impacts your ability to secure loans on favorable terms. It also means you have less credit available for emergencies. High utilization ratios may also indicate some deeper financial difficulties. If yours is creeping up, it may be time to do some serious budgeting.
There is no hard-and-fast rule, but many personal finance experts advise consumers to keep their utilization ratio below 30 percent.
4. You don't read your statement. With more banks pushing us toward paperless billing and automatic bill pay services, it's getting easier to skip looking over the monthly statement. The first danger here is that you may overlook erroneous charges and pay for products and services you haven't actually bought. You may even miss that you have been a victim of identity theft or other forms of credit fraud.
A more subtle danger associated with ignoring the monthly credit card statement is personal finance complacency. When we don't review and monitor our spending, we stop being in command of our finances, making it that much more difficult to reach our personal finance goals, whatever they may be.
Set aside a few moments every month to review your statements, whether paper or digital and make it part of a monthly budget review routine.
5. You haven't read the fine print. Do you know how your credit card issuer calculates and applies interest? Do you know what the fees are for late fees or credit limit overages? What about fees for cash advances?
Your bank is required by law to make all of that information available to you (and more), in an easy to read and understand format called the "Schumer Box," after Senator Charles Schumer of New York, who championed the law.
Before you apply and sign up for any credit account, make sure you understand the key terms spelled out in the Schumer box.
6. You apply for too many accounts at once. Every time you apply for a credit card you trigger a credit score inquiry. A couple inquiries won't impact your credit score, but several inquiries in a short period of time will affect your score, although the effect is minor. Experian, one of the big three credit bureaus, notes that while minor score adjustments don't harm those with good or excellent credit, consumers with weaker scores are at greater risk. Even a modest reduction in score, combined with other risk factors, can make it harder to secure additional credit.
There is an exception: Multiple inquiries made while rate shopping home and auto loans within a 30-day period are treated as a single inquiry.
7. You take cash advances. If you look at the line item for cash advances on your Schumer box, you may be stunned by the interest rate of your bank charges. A May CreditCards.com survey found that the average for cash advances is 23.53 percent -- or 8.54 percent higher than the average rate for purchases. Some banks even charge as much as 36 percent for cash advances! But the dangers of cash advances mount. Unlike charges for purchases, most banks begin applying interest the moment the advance is taken -- and this is on top of the 5 percent fee most charge to execute the advance.
Needless to say, consumers are wise to avoid cash advances, lest they find themselves caught in a never-ending debt treadmill.
You probably already understand the dangers of running up those credit card balances, but here are few more dangerous mistakes you may be making, plus some tips on how to avoid them.
1. You only pay the minimum due. Banks use several formulas to calculate the minimum amount due each month. Most start with a percent or two of the outstanding balance and then add in any fees for late payments, exceeding the credit limit, and monthly interest charges. However it's calculated, simply paying the minimum will result in lots and lots of interest payments over time.
You can find out how your credit card issuer calculates the minimum payment by visiting your issuer's website. Your bank's site may also include a calculator that shows you how long you'll owe -- and how much interest you'll pay -- if you merely pay the minimum. If not, try this credit card debt calculator.
2. You pay late. According to FICO, which generates credit scores, payment history is the largest component of a credit score -- 35 percent of the score, in fact. This makes sense because lenders want to know how promptly borrowers have paid in the past, and nobody likes getting paid late. Late payments mean a lower credit score.
There's a second danger here as well. Late payments will result in late payment fees from your bank, which not only cost you a bit more (or a lot more, depending on your agreement) but may also boost your monthly minimum (again, depending on your agreement).
3. Your utilization ratio is too high. After payment history, FICO looks at the "amount owed," which makes up 30 percent of a credit score. The key calculation here is the borrower's credit utilization ratio, which is how much available credit you use. For example, if you have a card with a $5,000 credit limit and a $2,500 balance, your utilization ratio is 50 percent. In generating the score, FICO analyzes each account and the total of all your accounts.
A high utilization ratio can harm your credit score, which impacts your ability to secure loans on favorable terms. It also means you have less credit available for emergencies. High utilization ratios may also indicate some deeper financial difficulties. If yours is creeping up, it may be time to do some serious budgeting.
There is no hard-and-fast rule, but many personal finance experts advise consumers to keep their utilization ratio below 30 percent.
4. You don't read your statement. With more banks pushing us toward paperless billing and automatic bill pay services, it's getting easier to skip looking over the monthly statement. The first danger here is that you may overlook erroneous charges and pay for products and services you haven't actually bought. You may even miss that you have been a victim of identity theft or other forms of credit fraud.
A more subtle danger associated with ignoring the monthly credit card statement is personal finance complacency. When we don't review and monitor our spending, we stop being in command of our finances, making it that much more difficult to reach our personal finance goals, whatever they may be.
Set aside a few moments every month to review your statements, whether paper or digital and make it part of a monthly budget review routine.
5. You haven't read the fine print. Do you know how your credit card issuer calculates and applies interest? Do you know what the fees are for late fees or credit limit overages? What about fees for cash advances?
Your bank is required by law to make all of that information available to you (and more), in an easy to read and understand format called the "Schumer Box," after Senator Charles Schumer of New York, who championed the law.
Before you apply and sign up for any credit account, make sure you understand the key terms spelled out in the Schumer box.
6. You apply for too many accounts at once. Every time you apply for a credit card you trigger a credit score inquiry. A couple inquiries won't impact your credit score, but several inquiries in a short period of time will affect your score, although the effect is minor. Experian, one of the big three credit bureaus, notes that while minor score adjustments don't harm those with good or excellent credit, consumers with weaker scores are at greater risk. Even a modest reduction in score, combined with other risk factors, can make it harder to secure additional credit.
There is an exception: Multiple inquiries made while rate shopping home and auto loans within a 30-day period are treated as a single inquiry.
7. You take cash advances. If you look at the line item for cash advances on your Schumer box, you may be stunned by the interest rate of your bank charges. A May CreditCards.com survey found that the average for cash advances is 23.53 percent -- or 8.54 percent higher than the average rate for purchases. Some banks even charge as much as 36 percent for cash advances! But the dangers of cash advances mount. Unlike charges for purchases, most banks begin applying interest the moment the advance is taken -- and this is on top of the 5 percent fee most charge to execute the advance.
Needless to say, consumers are wise to avoid cash advances, lest they find themselves caught in a never-ending debt treadmill.
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