Taking the Guesswork Out of Credit Counseling
While the idea of credit cards may be a relatively new concept when viewed in the scope of human history, the idea of credit may go back further than you thought. The first written record of it came from the King of Babylon almost 4,000 years ago in the Code of Hammurabi. Promising to pay money that you may or may not have at the time in exchange for products is nothing new to us.
Early in history, credit counseling wasn’t even a thought. It wasn’t until the late nineteenth century that the exchange of special coins and plates instead of currency sparked the idea of standardized credit payments. When the first credit card was used in 1946, it has has since become one of the most popular ways to purchase goods and services in the world.
Buying things with money that we don’t have can be very helpful in certain situations, but also very dangerous. Using someone else’s money can easily lead to the delusion that the money is yours, resulting in some dismal financial situations. If you have found yourself in such a situation, don’t panic—there’s a way out. The right credit counseling can drastically improve your financial circumstances, but first let’s establish a ground work of essential information to build our understanding on.
What is Credit?
In this information age of technology, it’s easy to take some concepts for granted. We need to first get a grasp of how credit has been integrated into our economy before we can move on to how we can fix our credit.
Each person who has ever borrowed money from an institution either through a loan or with a credit card has a credit score. This credit score is a number created by a mathematical algorithm that uses your credit report for its computations. Knowing what aspects of your report weigh the most heavily on your score can help you on the road to good credit.
Your score is a 3-digit number that banks and other financial institutions use to evaluate how much of a risk you pose to their investment. The more that you are late or default on your payments, the worse your score gets, and consequently the less favorable you will appear to a bank if you are applying for a loan.
Your score can be calculated by several models, but the one that is the most popular by far is your FICO credit score. This can be checked at myFICO.com for an estimate with an exact number behind a pay wall. When it comes to the score that banks and credit companies use, the FICO score comes out on top with 90 percent.
With your FICO score the higher the number, the lower the risk that you pose. That number ranges from 300, or extremely high risk, to 850, or extremely low risk. While the exact method of the algorithm’s calculation is a secret (much like Google’s search algorithm), certain aspects of your credit report weigh differently on your score.
Payment History: This is the most important part of your credit report. At 35 percent, this is the most influential factor that can drastically alter your score. Being delinquent on your payments can easily be the difference between a good and a bad score.
Amounts Owed: This is the total of all of the debt that you have across all of your accounts. This is the second heaviest factor at 30 percent. Focusing on these first two aspects of your report is paramount to fixing your credit.
Length of Credit History: This takes into account how long you’ve been using credit. This factor will also place you in a different scoring bracket since people with younger histories haven’t had the opportunity to accumulate good or bad credit.
Types of Credit Used: If you have several types of accounts open, like installment or revolving accounts, this will impact your score. However, opening new accounts simply to diversify your credit mix isn’t advised as this is risky behavior and only has a 10 percent influence on your score. Only open accounts when the situation calls for it.
New Credit: this combines your interest in your credit report (i.e. credit checks and asking for your report) and how many accounts you’ve opened in the recent past.
Across the board, these are the aspects that influence your score. Don’t listen to anyone who tells you that FICO takes demographics like race or age into account. The question is: How can you use this credit info to improve your score?
Tips on Building Good Credit
Now that you know the way that your FICO score is calculated, you can identify the areas of your credit activity that have caused your score to flourish or suffer, and change them if necessary. There isn’t a set amount of change that happens when you purchase a certain item with your credit card or submit a late payment, but by knowing which aspects affect your score, you can make lifestyle changes to start building credit the right way.
If you have visited a score provider and you have found that your score needs some serious improvement, there are ways to receive credit help. The great news about credit institutions is that they are forgiving, given time. As your past mistakes or problems fade into the past, so does their impact. No blight lasts forever.
Since your payment history is the most influential scoring factor, an important first step to take is this: pay your bills on time. No, don’t stop using credit, that won’t erase the past and won’t be a step toward building credit. Instead, alter the amount that you accrue debt and work on credit management. The more bills that you pay before the deadline, the more your score will increase over time.
If you’re new to the credit scene and you are looking for advice for starting off on the right foot, pay your bills on time. This is a fundamental concept that seems intuitive, but can be difficult to execute if you become frivolous with your spending. Ultimately, you need to consider your spending habits and alter them so that you use a manageable amount of credit, thereby leading to manageable payments that you can meet each month.
Another tip to follow if you have a relatively short credit history is to avoid opening multiple accounts at the same time. This can seem like impulsive and risky behavior that can easily hurt your scores. Stick with one or two accounts in the beginning and only add more if they are necessary.
A good spending philosophy to have is to reserve your credit card for things that you need like groceries, gas, and rent. If I wanted to fix my credit, I would only use my credit card when I have that amount and more in my bank account. While this practice may just seem like a debit card with more hassle, it will help you keep your monthly payments manageable and will build good credit for those rare times when you need more money than you have.
One thing to avoid is using other accounts to pay off debt that you already have. Moving your debt around rather than paying it off can negatively affect your score. However, you might be in a dire situation that may require you to consolidate your debt in order to make your monthly payments manageable.
What is Credit Consolidation?
Put simply, credit consolidation is when you take all of the debts you owe—whether it be medical bills, car payments, student loans, or credit cards—and combine them into one consolidated loan, giving you one monthly payment as opposed to five or six. This has multiple advantages if you find yourself in a hole with no perceivable way of escaping.
Aside from the single payment advantage, consolidating your debt can lead to lower interest rates, smaller monthly payments, a better credit score, and a clear path out of debt. There are two main ways to achieve consolidated credit.
Debt Management Plans– or DMPs are the more popular route when it comes to credit consolidation. Since many Debt Management Plans are offered by non-profit organizations, they present a viable credit solution to those in serious debt. After a credit counseling consultation to assess how much you can afford in your monthly payments, the agency will fight for a lower interest rate and a late fee reduction to help you get back on your feet.
Once a monthly payment for each creditor is reached within your budget, they distribute the total payment among your creditors for you. Besides the obvious benefits of having lower rates and payments, it can also help you feel less overwhelmed and more in-control of your finances. By the time three to five years go by, you should find yourself out from under the burden of debt and practicing good credit building techniques.
Debt Consolidation Loans– are mostly designed for people who struggle with having too much debt spread over too many credit cards by essentially giving you a loan for an amount that covers all of your various debts. The single monthly payment on this loan will replace the multitude of payments on your cards, making it much more manageable on your finances. If this is the route you choose, you’ll have two options to choose from.
- Secured Loans: this type of Debt Consolidation Loan is linked to an asset as collateral—such as your car or your house—and generally offers lower interest rates. This option is best for you if you’re debt amount is substantial, since these loans usually allow for large amounts of money to be loaned. However, as it is linked to your asset, you risk losing that asset should you default on the loan.
- Unsecured Loans: These are more difficult to get from a lender and usually don’t allow for large amounts of borrowing, but they are not connected to your assets and give you a shorter repayment term, which means less interest over time.
For other finances (e.g. rent, mortgage, electricity, or telephone bills) there are also options to consolidate your bills. This will require you to have an exceptional credit score of over 700 so that you can qualify for a no-interest transfer card. Any payment you make during the 6-18 month period without interest will go entirely toward your debt.
How Can Credit Counseling Help?
Like many difficult situations in life, seeking quality advice from a professional is usually a good starting point. A counseling session with credit consultants can take place in an office or over the phone and is generally free of charge. If you’re looking for a way to fix credit problems, here are some things you should know before going into a session.
- Make sure that you have all of your up-to-date financial information with you at the office or on-hand on the phone. If you aren’t able to provide recent details about your credit history, then the counselor will be unable to present any viable credit solutions. This includes bills, paystubs, and a general idea of how much you spend on the essentials each month (i.e. food, rent, transportation).
- When you’re in the session with your credit consultants, be frank with your financial situation even if it doesn’t make you look very good. Your counselor is not there to judge you, only to help. If you hide your credit info, he/she won’t be able to get a full grasp of your situation.
- Your counselor will give you specific advice about your finances to help you manage your spending and give you information about payment strategies.
- You will then get an action plan that includes a new budget. This may mean cutting spending, credit consolidation, or reducing the amount of credit cards you use. This action plan will be unique to your situation and will help you start your journey to being debt free.
For a free counseling session, you can visit www.credit.org.
If you had a serious medical issue, you would consult a doctor. If you had a problem that required the court system, you would consult a lawyer. It is just as important to seek professional advice concerning financial problems. There are organizations out there that are fully capable of helping you deal with your situation, no matter how dismal it may seem. Your circumstances may seem unique, but it isn’t anything that seasoned counselors haven’t helped others through.
Realize your situation, identify the source of the problem, consider your options, and work with a professional. Follow these steps and entertain the possibility of a debt-free life. If you are new to credit and you are looking for good advice on how to start off right, look no further than a credit counselor. An action plan isn’t just for those in trouble, it’s for anyone who wants to live and spend responsibly.
Article written and contributed by Carlos Rivera