How to re-establish responsible credit card use after debt problems
Dear New Frugal You,
I had my fill of debt and went on a Dave Ramsey-style debt diet. All the debt is gone now, and so are the credit cards. But when I check my credit scores, they're still not so hot, and I want to borrow to buy a car soon. And once this mess is over, maybe buy a house. I live on the cheap and think I can handle credit. Help me over the threshold or wave me off. Do I throw myself back into spending on credit cards? Or not? -- Credit Conflicted
Dear Credit Conflicted,
Congratulations CC! You've already taken the biggest step to a higher credit score. You've paid all your debts! Now the next step is to build it further before applying for an auto loan or mortgage. So what will it take to boost that score?
The only people who know for sure exactly how much anything will affect your credit score is FICO, the creator of the most widely used credit score. And they only put out guidelines for us to use.
However, they do say that roughly 35 percent of your FICO score is determined by your payment history. If your score is low today, I'd guess that you've had some problems with late payments in the past. Only the passage of time (measured in years, not months) will correct that.
One way to help offset past payment problems is to build a squeaky clean history, beginning today. Unfortunately, not everyone that you do business with reports to the credit agency. On-time payments for rent and utilities may not be reported.
So you need to decide whether to begin using credit cards again. But, the decision shouldn't be left to me -- or even to whether credit cards would help your FICO score.
Why? Because not everyone can safely handle credit. Using credit cards is a little like drinking. Most people can take an occasional drink without becoming drunk or doing anything stupid. But there are some who can't. They need to avoid alcohol completely.
The same is true of credit card use. Some people can use credit without increasing their spending or building up a balance owed. But others cannot. Like the alcoholic, they need to avoid credit cards completely.
If you feel that you can handle credit safely, open just one or two credit card accounts. Promise yourself that you'll pay the bill completely each month. The first time that you cannot pay the whole bill, cut up the credit card so that you cannot use it again.
And, don't buy things just so you'll have something to pay for. Only make purchases that you would have made if you were using cash. Then pay off the whole balance when the bill comes in.
Remember that the worst thing you can do for your credit score is to get a handful of credit cards, charge them up and then fall behind on the payments. Do whatever it takes to avoid this scenerio.
Trouble controlling credit cards and spending means that you need to try to learn why you have a problem. One excellent book is "The Financial Wisdom of Ebenezer Scrooge" by Klontz, Kahler and Klontz. It's an easy, entertaining and informative read that will help you understand why you make the financial decisions that you do.
If you ask enough financial advisers, you'll find some -- probably including Dave Ramsey -- who would tell you not to open any credit accounts. They'd say that, on average, people spend more if they use a credit card. And their statistics would be right, although somewhat misleading. On average, people DO tend to spend more using credit. But those averages are made of some people who spend a lot more using credit and others who don't spend any more. Can you be one of the latter?
Obviously, if you're not sure what you'll do, then the safest path is to never use credit. But if you want to boost your credit score, using credit cautiously and wisely can help display your ability to use credit.
Ultimately, your goal is to be able to buy a car and then a home. You're right. You will want the best credit score possible when you do that. But you'll also help yourself by living cheaply and saving as much money as you can. If possible, save enough to pay cash for the car and have a sizeable down payment on a home.
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