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A recent survey by U.S. News & World Report found that 68% of consumers with bad credit are working towards improving their credit score, yet 35% admit that they didn’t do any research the last time they applied for a credit card. While many young people are taking steps toward living debt free, most consumers aren’t aware of how their credit score is calculated or what they can do to improve it. Choosing a credit card that benefits you can help you to get out of debt and improve your credit score, but this only works if you understand how to use it to your advantage.
According to the U.S. News & World Report survey, about half of people with bad credit have used credit cards to pay for basic necessities in the past year. Despite this heavy reliance on credit cards, 60% of people say they spent less than an hour researching rates, fees and terms when applying for a new credit card, and 35% did no research at all. Skipping this crucial step is both costly and damaging in the long run, especially when carrying high interest balances without a plan to pay them off.
In addition to the over-reliance on credit cards, only 24% of consumers with bad debt check their credit score on a monthly basis, which is the frequency recommended by most financial experts. Without knowing where your score lies and what goes into it, it’s very difficult to take steps toward improving it, so the first step is to educate yourself on the basics of what goes into your score.
Credit Score Basics
There are a few key factors that are taken into account when calculating your credit score, and each factor is weighted differently. The list below shows a simple breakdown of the main influencing factors on your score.
|Credit Card Utilization||High|
|Age of Credit History||Medium|
|Number of Accounts||Low|
While most of these categories speak for themselves, credit card utilization seems to be the one that causes the most confusion when it comes to improving your score. This calculation is the ratio between the total balance on all of your cards combined to your total credit limit. If you have a credit card with a $5,000 limit and another with a $10,000 limit, and you currently owe $3,000 between them, this would be a credit utilization ratio of 20% ($3,000 usage/$15,000 limit). Ideally, you want your credit utilization below 10% but above zero; not using your credit cards at all or paying them off in full is actually seen as a negative, since you aren’t showing that you can responsibly handle debt.
Know Before you Apply
Since high credit utilization is one of the biggest obstacles to those with bad credit, knowing what to look for in a credit card is key to getting your credit score under control. Shopping around is important to compare interest rates, fees, and terms and conditions on a number of cards before selecting one.
An important thing to keep in mind is that if you want to shop around within a short window of time; if your credit gets run multiple times for multiple applications, it hits your credit score multiple times unless you apply to all of them within about a two-week period. Credit bureaus take into account that this is likely comparison shopping, and you only get dinged with one hard inquiry on your report rather than multiple, which take 2 years to fall off your report.
Choosing a Credit Card
One of my personal favorite options is finding a good balance transfer card, which can give you an advantage when trying to pay down your credit card debt. By essentially moving your debt from one card with a high interest rate to another with a lower interest rate, you decrease the total amount you will need to pay off without spending any additional money.
There are a lot of credit cards out there and they all want your business, so be sure to choose wisely; research interest rates, annual fees, and any special rewards or points programs they might offer. Taking the first card that’s offered to you might be tempting, but spend some time reading up on which cards will work best for you, and limit your applications to avoid additional hits on your hard inquiries.
While every person has their own individual needs when addressing their credit, there are some types of cards to avoid when you’re working to get out of debt. Avoid anything with no grace period; this is when interest starts accruing the moment you make a purchase, rather than each month following your statement date.
Also be sure to avoid cards that are actually lines of credit, rather than traditional credit cards; interest rates are exponentially higher and they can lock you into lease agreements for the goods you buy. Store credit cards can be beneficial, but be sure it’s somewhere you already shop, and that their benefits are worth getting the card; generally speaking, avoiding annual fees is best here as well.
Once you’ve chosen the right credit card and been approved, make sure you are using it to improve your credit. Make your payments on time and manage your utilization; setting up automatic payments makes it easy to stay on top of your debt without missing a payment. If your card gives cash back or rewards, always apply these directly to your balance, and keep checking your score to see your improvement!
For the full survey report and guide, visit U.S. News & World Report here.
For more information on credit cards and how to use them to your advantage, see my post here.
For real ways to improve your credit score today without paying anything, see my post here.