October 10, 2012
By Lila Quintiliani, AFC©
Assistant Coordinator, Military Saves
I have counseled servicemembers who had lots of debt and I have counseled very young servicemembers who had no debt at all, and they both faced the same problem -- very low credit scores. How could this be, you might ask? How can someone who has no credit cards and no car payments still have trouble getting a loan or applying for a store card? Well, you can think of credit scores as your “reputation” with the credit bureaus and the Fair Isaac Corporation (the company behind FICO scores): a good credit history, showing on time payments and a low debt to available credit ratio,goes a long way toward building a positive credit “character.”
But the sad reality is if you are very young, just starting out, and have no credit cards and have never had a car note or other type of loan, you can look just as risky to a potential creditor as someone with lots of debt. And the same goes for someone who has paid off their debts and has closed all their credit card accounts. Suddenly they may find that they have an incredibly low credit score. When they go to apply for an auto loan, they may find themselves being offered rates in the 20+% range, or they may even be turned down.
But aren’t credit cards a bad thing to have? Well, they can be. But they can also be a good thing. When used wisely (and in my mind, that means you pay off the balance each month), credit cards can help build a better credit score, which will result in lower interest rates on loans, better insurance rates, better mortgage rates, and an easier time getting a security clearance. If you are a responsible credit card user and pay off the balance each month, you could also look at credit cards that offer reward programs such as points, cash back or airline miles. Some credit cards also carry other benefits, such as rental car insurance, extended warranties and the ability to dispute purchases if you are dissatisfied. If you pay off the balance each month (sensing a theme here?), credit cards can also be safer to carry than cash, since under the provisions of the Truth in Lending Act, you cannot be held responsible for more than $50 if your card is lost, stolen or used without your authorization.
How can I get credit if I don’t have any? Due to the CARD Act, which went into effect in 2009, it’s now much more difficult to get a credit card (and that’s a good thing!). Typically, the best place to start out is to get a store credit card, but they also come with some of the highest interest rates out there, so, you guessed it, you will have to make sure you pay off the balance each month. If you open a card because it’s 0% for a certain number of months, then make sure you know what the payoff date is going to be, because after the promotional rate expires, you could be charged an outrageously high interest rate for the entire period. Some people also use secured credit cards (cards where you are required to make a deposit in an account equal to your credit limit on the card) as a route to establishing credit, but you have to be careful: aside from the inconvenience of having to secure the card with a cash deposit, there may be fees involved. And not all secured cards report to the three major credit bureaus, so you may find yourself going through a great deal of trouble and not getting much out of it.
What if I can’t trust myself with a credit card in my wallet? Some people just can’t stop themselves from using a card if they have it. Could you leave the card somewhere safe at home? If you can’t, then you may even consider cutting the card up without closing out the account. To maintain your credit history, you really don’t want to close every card you own. If you do feel compelled to close accounts, close newer accounts, because the length of your credit history is a component of your score.
Credit cards have their advantages, but they should not be undertaken lightly. They are a responsibility, and if you misuse them, it can reflect very negatively on you for many years to come. So use them cautiously, and be aware of the repercussions they can have on many other aspects of your life. Oh, and always pay off the balance each month!