Saturday, March 29, 2014

The Strange World of Credit Cards and Credit Scores

Recently Discover has started including your credit score on the bills it sends you. Mine went up 6 points from one month to the next.

I’ve always found trying to figure out how your credit score is calculated as clear as mud. Too many credit cards can bring down your score. Because the more cards you have the higher your total purchasing power is. The more temptation to spend, spend, spend. Running up your debt that’s not a good thing.

The obvious thing to learn from that is that you should cancel cards you don’t use. But that could be a bad thing. Cards that you’ve had for a long time you should keep because that shows a long term credit history.

Also by canceling a card it actually increases the over all percentage of your debt. For example let’s say you have $2,500 in credit card debt. The total credit line you have on all your cards is $10,000. That means the percentage of your debt to the combined credit line is 25%. Let’s say you have a card that you don’t use with a credit limit of $5,000. It has a really high interest rate so you cancel it. Your total credit line for all your cards is $5,000. Suddenly your debt to the combined credit line is 50%. So it means your score will take a hit. Because if you just use percentages it looks like you’ve doubled your debt.

In other words just about no matter what you do, you end up hurting your credit score. Probably the best thing to do if you have a card with a high rate is having something charged to it on a regular basis. Put your Netflix account on it. Or use it to charge gas. Each month you make sure the balance is paid off.

I use my Sears card for that. I got it when my refrigerator died. I got no interest if I paid off the balance in a year. I did it way before that. Of course I now have this card with a ridiculous interest rate of 25%. Why would you keep a balance on this card. But I can keep the account active by having my gym membership on it. And I make sure I pay it off each month.

The other thing I find interesting is the number of balance transfer offers I get. Not only through the mail but e-mail offers as well. Sears is really after me to do a balance transfer. I never respond to those. I have used other offers. Usually you get a year with no interest. There’s also the transfer fee which can vary anywhere from 2-5% of the amount you transfer.

What’s the idea behind it? The banks want to hook you into using that card and running up charges. The idea is you won’t pay off the balance in time and the credit card company starts charging you interest on that balance. The way payments are applied helps that become a reality. The minimum payment is usually applied to the balance with the lowest interest which of course would be the balance transfer. The rest is then applied to the balance with the highest interest charge i.e. the things you are charging. This way it takes a long time for the amount of the transfer to go down. In all likelihood it won’t be paid off in the time you were given to do so.

Best thing to do is divide the amount of transfer by how many weeks you get the zero interest for. That gives you how much you need to pay each week to have the transfer paid off in the time. Then you set up a weekly payment in that amount. When the bill comes each month, you pay the minimum plus whatever interest is charged on the account.

The goal is to beat the credit companies at their own game. Pay the transfer off and the only thing they get from you is the transfer fee. It's not exactly free money but it is really cheap money.

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