Photo by [adamr]
Credit cards is quite the scary term to some. If you’ve ever had your FICO score destroyed due to poor credit card usage then you may know what I mean.
Believe it or not, there is a right way, and a bad way to manage the credit extended to you by lenders. Getting the highest credit limits and going on shopping sprees is definitely NOT the right way to manage your credit cards.
The FICO Scoring Model
The FICO scoring model is made up of several different parts, all of which will change on a daily basis depending on what is going on with your finances and trade lines. Some people may even look at their FICO score as a live entity because it changes so much.
The FICO Scoring Model
Your credit score is calculated based on certain percentages.
1. Payment history accounts for 35% of that score. Paying your bills on time, every time will drastically effect your score.
2. The Amounts owed accounts for another 30% of your score. If you have trade lines consisting of Revolving trade lines such as credit cards, or installment loans, this 30% is calculated by dividing the amount owed by the total available credit. The percentage this calculation brings is also known as utilization percentage.
For sufficient FICO scoring which will avoid adverse action from creditors, it’s best to keep your total utilization below 30%. But for optimal scoring, if you keep the total revolving utilization below 9%, this will give you the best possible score. This is especially important if you are planning to apply for any future credit. This 9% threshold may vary a bit between 1%-9% depending on your trade lines and total available limits. It’s also a known fact that letting only 1 credit card report this small balance while all other cards report a $0 balance is best.
3. Length of credit history is 15% of the FICO scoring model. This is also known as AAoA (Average Age of Accounts). Most consumers with scores above the 800 mark will have an AAoA above 6 years. This is calculated by adding together the age each one of your trade lines has been open and dividing it by the total number of accounts.
4. New credit acquired accounts for 10% of FICO. When ever a new trade line is added to your credit report you will see a small drop in score. This is directly related to your AAoA. By adding a new account, it is dropping your AAoA, thus dropping your score. Every time you apply for credit, the creditor will pull your credit report and this is called an inquiry. And let’s not forget that by adding another Inquiry to your credit report, that also may drop your score a few points. But score drops for inquiries and adding new accounts will recover quite quickly, with a few months.
5. Types of credit used will account for the last 10% of your score. It’s said for optimal score it’s best to have a good mix of trade lines. Meaning a few credit cards, installment loans, mortgage, car loan. To have a little bit of all the above looks best to creditors and will yield you the best FICO score.
How do I Pay My Credit Card Bills
One very important thing we need to look at next is the difference between your Statement Cut Date and the Payment Due Date. Normally with all credit card lenders your payment due date falls 3 days prior to your statement cut date. The current credit used that is reported to the credit bureaus comes from the balance shown on your current statement. So what ever your balance is when the statement cuts, that’s what will be reported. So in order to control your FICO score and utilization, it’s best to pay down what ever you don’t want to report prior to your statement cut date.
Once a statement cuts, your payment due date will normally be approximately 25 days after that. In order to avoid interest payments, it’s important to pay your balance in full prior to that due date. It is never advised to only make the minimum payment required each month. This can appear as risky behavior to creditors and may result in adverse action by them. Meaning they may start balance chasing you, which is when they lower your available credit to just above what you owe to keep you from charging more. Normally when they do this it is also followed by account closure upon paying off your balance.
No one would want this right? The best way to avoid adverse action, especially if you must carry a balance, is to make substantially more than your minimum payment each month. Most creditors would like to see you paying at least 10%-20% of what your current balance is each month, if you’re not paying in full.
How to Obtain a Credit Line Increase
One thing that will let you know you’re managing your credit cards wisely is when you log into your account and notice you’ve been given a credit line increase! Woo-Hoo! Job well done!
But you may be asking, “How do I get a credit line increase”. First let’s look at the reasons we would want a credit line increase.
Having a higher credit line means lower utilization, more spending power and a higher FICO score. Personally I love using credit cards that offer a rewards program. There are many different types of rewards programs such as cash back, mileage points (If you fly frequently), points toward spending. Some have rotating categories every quarter such as Discover It and Chase Freedom. By taking advantage of these rewards you can actually reduce the amount you are spending each month.
But the best way to do this is to use your credit cards for everything you possibly can. These rewards can really add up quickly if you’re using them this way. But remember, we should never look at our credit limits as “extra spending money”. I find it best to look at my credit cards as a debit card. I never spend beyond what I currently have in the bank, and when it comes time to pay, I simply transfer the money from my bank account to pay my bills.
I merely spend what I would of spent anyway, but I put the charges on my credit cards. This is the best way to utilize your cards which will keep that good payment history flowing, keep your creditors happy, and will make you eligible for credit line increases.
Most creditors will do a manual review of your accounts activity every 6 months or so. When they see you’ve always paid your bills on time, and made more than the minimum payment. Or that you’ve never gone over your credit limit and paid you statements in full each month and are keeping your utilization low, then you’re almost guaranteed they will automatically give you a nice increase in spending. They love risk free customers and will reward them accordingly. It make them more money and makes the consumer more too by way of rewards.
How Do I Build Credit
Of course this may not be the case will all lenders, some of them simply do not give increases and you have to go through much headache in order to obtain one. Capital One is notorious for not giving credit line increases, but there is a reason for this. Capital One has what’s called tiered cards. All of their cards are designed in specific tiers made for different levels of credit worthiness. So the only way to get an increase in credit line is basically to apply for a higher tier card. So it’s best to wait until you can be approved for a higher tier card from the beginning, if you want to see the card grow with you.
But we all have to start somewhere right? So for some, just getting approved can be a great deal of work. If your score only allows for a lower tier card or a secured card from someone like Bank of America or Wells Fargo, then by all means don’t wait, get the card. Because after 6 months to a year of on time payments and good account management, your score will have improved dramatically and you can then apply for your dream card. Most creditors require a certain amount of payment history on revolving accounts before they will even consider your application. So this is a great way to build credit, or rebuild for some of you.
Handling Bad Accounts
The most important thing to accomplish when building or rebuilding your credit profile is to get rid of those accounts in bad standing that are effecting your credit score. If you want to build your credit you have a couple of options when it comes to bad accounts. You can either wait for them to fall off of your reports, which takes normally 7 years from the date of final delinquency. Or you can contact the creditors and work out a deal with them.
Sometimes when worst comes to worst you may have to settle payment with them. Meaning they agree to take less than owed in order to close the account as paid. But this will list the account as a settlement on your credit report and is not advised. Another option is to contact them in writing asking that they delete the bad trade line from your report if you pay the debt in full. Remember, not all creditors will accept this offer, but many will. Then there’s the “Good Will” letters. Many people have had good luck writing “Good Will” letters to creditors asking to have the bad trade line removed from their report. But this will only work if the debt has been paid. This is also a good tactic in trying to remove late payments from their reported trade line. This has also been successfully done by many folks.
It may not always be necessary to get all bad marks removed from your reports before applying for credit. But it will greatly increase your chances for approval. It’s best to at least try as hard as possible to get most of it resolved.
Find a Secured Product
Once you’ve done all you can to repair you report, then it’s time to rebuild. This can be done in many different ways. Some people will reach out to a local credit union and open a secured loan. This will not only establish a good working relationship with a lending institution, but will add a positive trade line to your credit portfolio. Of course once you’ve paid the loan off, you will get your deposit back usually with interest earned.
Once you’ve successfully paid your secured loan back, the chances of getting approved by them for a unsecured credit card are quite high.
Another method is to open a secured credit card with someone. Bank of America, Wells Fargo, Capital One just to name a few have excellent secured products and the Bank of America card can even come with a rewards structure. I also believe Bank of America and Wells Fargo secured cards are known to unsecure and return your deposit after one year of good account management.
After 6 months to a year of good account management with your secured card, you should be ready to apply for something better. Just be sure which ever secured card you get will report to all three credit bureaus.
Well, I could go on and on about credit and the best ways to use it, mainly because it is an extreme passion for me. I’ve made credit management into a hobby and have spent thousands of hours reading and learning all the ins and outs of it. So I wanted to share some of my knowledge with my readers.
There’s nothing we can’t accomplish when we’ve set our minds to it. But remember, none of this will happen over night, building or rebuilding your credit profile takes time, but the rewards are sweet. So get ready to learn along the way, if you want a great place to start, check out my favorite forum in the world, myFICO. I wish you all the best in your credit building journey.