It is a little frustrating that many of the events that lead up to the decision to file for bankruptcy are out of our control. How, for example, could the average homebuyer have guessed home values would drop so significantly after so many years of steady gains? Nevertheless, it happened, and homeowners were left to clean up someone else’s mess.
When it comes handling credit card debt, some consumers may find themselves in trouble simply because they have misconceptions about how revolving credit affects your credit score. It’s true: There are consumers that max out their credit cards with the intention of bolstering their credit worthiness and their credit scores.
Credit industry analysts and credit advisors say that Millennials in particular don’t understand how credit cards affect their credit scores. The cardholders in the younger generation are holding onto large balances — balances that collect interest — as a way to build a good credit history. They believe that their FICO scores will improve because they carry a few thousand dollars of debt at all times.
Not at all, says one financial advisor. FICO rewards low balances and on-time payments more than anything else. A cardholder’s payment record accounts for 35 percent of his or her FICO score, and the amount of debt compared to credit limit accounts for 30 percent. The idea is to rate cardholders on how responsible they are with the credit they have.
For payment, high marks go to cardholders who consistently pay on time. When it comes to account balances, the ideal is a $0 balance, but high marks will go to cardholders who can maintain a balance that is 30 percent of the credit limit.
Cardholders who are not worried about their credit scores should keep balances low for another reason: The money they are paying in interest on high balances could be put into savings or a retirement plan. Still, if a card has a $0 balance, don’t cancel the card, the advisors say. FICO also looks at debt capacity — that is, the difference between card balance and credit limit — again as a way to measure how responsible the cardholder is with his credit.
Source: Main Street, “Why Carrying That Huge Credit Card Balance Isn’t Helping Your Credit,” Jason Notte, April 13, 2015