How do you use credit? There are right ways and wrong ways, and the latter almost always lands you in trouble.
Consumer credit as we know it has evolved fairly quickly in the last four decades. Before the late 1970s few people had credit cards. Even if they had a Mastercard or Visa – it used to be called BankAmericard – they rarely had more than one.
Over the years, having credit cards allowed consumers to expand their purchasing power, sometimes buying things they really couldn't afford. But it stimulated the economy and generated income for the banks so everyone was happy.
End of the party
Eventually it caught up with us. The credit crisis of 2008 was about more than mortgages. In its aftermath credit card companies reduced customers' credit lines and in some cases, unilaterally closed accounts.
Even now, more than four years later, we're still left with a significant credit balance. Combining credit statistics from a number of federal agencies, NextAdvisor.com, a financial research site, came up with the top credit mistakes that consumers make.
For example, the company cites Federal Reserve data showing consumers carry more than $793 billion in credit card debt. That debt is borne by the 46% of credit card holders who don't pay off their full balance each month.
“If you're not paying your credit card balance each month, you're paying interest in addition to the principal your owe,” said Jeff Hindenach, director of content for NextAdvisor. “I think the most shocking statistic is the $22.5 billion in credit card penalty fees. That's people paying their credit card bill late or going over their credit limit. These are penalties that no one should have to pay.”
Not only that, 36% of consumers are unaware of the interest rate on their credit cards. Maybe knowing the rate isn't very important if you pay the balance down to zero each month, but if you carry a balance, it's information you really need to know.
“If you don't know what interest rate you're paying and its 22%, then you're paying a lot more interest than you should be paying,” Hindenach said. “There are balance transfer cards out there that can save a lot of money but you have to be aware of your interest rate in order to take advantage of them.”
A recent Federal Trade Commission (FTC) study showed that 42 million consumers have errors on their credit reports that they do not know about. Hindenach says it's just more evidence that consumers are not always aware of the credit mistakes they are making.
Credit report errors
“Errors in your credit report will obviously lower your credit score and a lower credit score can often times mean a higher interest rate,” he said. “If your credit score dips low enough you could have problems getting credit cards, getting loans, getting a mortgage.”
To make sure the information in your credit file is accurate, you should go to www.annualcreditreport.com, a site sanctioned by the U.S. government, and download your credit reports, at no charge, from all three credit reporting agencies – Experian, Equifax and TransUnion. If you find inaccurate information, go to the website for the agency containing the errors and look for instructions for disputing the information and seeking a correction.
“After you file that paperwork, which is actually like a letter, they have 30 days to respond,” Hindenach said. “Resolution is fairly quick.”
Not always wise to close credit accounts
When examining your credit report you may see a number of credit accounts you are not using. But don't close them. Sometimes, doing that can negatively impact your credit score.
Instead, if you make a couple of small purchases each year on a little-used credit card and pay off the balance immediately, it will boost your credit score. Carrying a credit card balance, especially a large one, not only limits your purchasing power but can lower your credit score over time.
“It would be great if schools started having some sort of financial literacy class for students,” Hindenach said. Something we advocate is parents talking to their kids about credit at an early age.”
Then again, a lot of parents will probably need to educate themselves about credit and break some bad habits too.