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Want debt trouble? Do this
Let’s be frank: There is no such thing as “good” debt.
Still, most people have some kind of debt, and these financial obligations aren’t all evil.
From credit cards, student loans and home mortgages to auto financing, payday loans and more, each type of debt comes with its own concerns for borrowers.
Yet, there are some broad principles that apply to all debt. Violate them and you could find yourself in a world of hurt with respect to how much you owe and how much it ultimately will cost you to pay if off.
With that in mind, here are 6 things you definitely do not want to do with respect to your credit and debt this year.
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Spend, spend, spend
It’s hard to have great credit if you don’t have savings, says Rod Griffin, director of education at Experian, a global credit information company in Costa Mesa, California.
Accidents, illnesses and other emergencies are a fact of life, and without a financial cushion, you’ll be much more likely to use debt, whether it’s a credit card or payday loan, as a solution.
That puts you at risk of having more debt than you can manage and it spikes your credit utilization, which can hurt your credit score.
“People who have savings are able to weather a financial downturn and protect their credit. If you don’t have savings, everything tends to spiral very quickly,” Griffin says. “Saving is a critical part of using credit.”
People who have good credit generally have good saving habits, he says.
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The start of a new year is a good time to plan how much debt you intend to pay down, by when, and how, says Cheryl Krueger, president of Growing Fortunes Financial Partners, a financial planning firm in Schaumburg, Illinois.
“Setting aside time to review what your income is, what your expenses are and (how you can) try not to take on debt that you can’t afford is really important,” Krueger says. “It creates a level of conscientiousness toward what you’re spending and you may have to change your habits.”
One debt repayment strategy is to budget a set amount every month toward this goal. Make the minimum payment on all but one of your debts and then pay the rest toward that one, whether it has the lowest balance or highest rate.
Even if you don’t have more debt than you believe you can handle, it’s still smart to pay off as much as you can before you retire, Krueger says. Being debt-free gives retirees more flexibility with their finances.
Bruce McClary, spokesman at the National Foundation for Credit Counseling, a national nonprofit that offers financial education and counseling services, says it is possible to use credit cards responsibly.
“By not carrying a balance from month-to-month, you can be living relatively debt-free while saving yourself from having to pay the full price for borrowing,” he says.
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Ignore interest rates
If you don’t pay off a balance in full every month, the interest rate determines the cost to you of “carrying” that balance to the next month. Higher rates cost you more and can slow your progress to pay off debt.
“If you have access to something, like 18 months with a lower rate on a credit card, that allows you to bring that rate down, that can be helpful because you’re paying less interest and more principal,” Krueger says.
Interest rates on credit cards and other loans aren’t always prominently displayed on statements or online, so you might have to do some digging to find out what they are, she says.
McClary says that research is worth the effort.
“If your rate on your credit card is 20%, 25% or even 30%, you really need to see what you can do to get that rate lowered and clear the balance,” he says. “Make a plan to pay it down faster or consolidate into a lower-interest product.”
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Make late payments
One of the worst things you can do to your credit is make late payments, Experian’s Griffin says.
Payments you make after the due date instead of on time will lower your credit score, giving you less access to credit and on less favorable terms.
“If you have late payments on accounts that will have the first and most significant impact on lending decisions and your ability to qualify for additional credit,” Griffin explains. “If you’re behind on payments, the first step you should take is to catch up and bring those accounts current.”
McClary points out the connection between making late payments and not having a budget.
“Paying late is a significant mistake,” he says. “If you’re not keeping track of your budget, you’re increasing the chance that you’ll make your payment late, incur late fees and run into trouble with your credit score.”
Krueger says it’s never too late to acquire the on-time-payment habit.
“There are a lot of ways to improve credit scores. Not letting them get low in the first place is the easiest,” she says.
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Another of the other worst things you can do to your credit is overutilize or “max out” the credit that’s available to you.
“If you have high balances compared to your credit limits, that will affect your credit scores,” Griffin says — and not in a good way.
There’s no ideal level of credit utilization, but experts say 30%-35% should be a maximum.
People who have excellent credit generally use much less.
“People with the very best credit scores have utilization rates of less than 10%,” Griffin says. “The lower the utilization, the better for your credit score.”
That said, it’s not necessary to obsess about the ideal number of credit cards you should have or specific amount of debt you should carry on any one card or in total.
“The people with the best credit scores don’t obsess about perfect ratios or a perfect number of credit cards. They focus on paying their bills on time every month and not overusing the credit that’s available to them,” Griffin says.
Get those basics right, and you won’t have to try to finesse the system.
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Ignore your credit report
It’s difficult to manage your credit and debt if you don’t know how much you have.
That’s one reason why you should get your credit report and review the status of all your accounts at least once a year. You can get a free copy of your report annually (or in some cases more often) by law.
Your report gives you a baseline of where to start to improve your creditworthiness.
Griffin says many people have unpaid accounts they’ve forgotten about or accounts that are open, but inactive. These account can hurt you in ways you’re not even aware of.
McClary says consumers should keep their financial records and compare them with their credit report, hunting for any mistakes they can correct.
“Look at how creditors are reporting the timeliness of your payment, amount you owe them, how much you pay each month and how long the account has been open,” he says.
By scrutinizing those details, you can identify errors that might be the result of identity theft or fraud and make sure your report is corrected.
“You don’t want somebody else’s criminal activity to hurt your borrowing ability or the interest rate you qualify for,” McClary says.