January 20, 2017
More often than you’d think, I get a call from a panicked client, “Sandi, I can’t believe it… I have a LOW credit score. What do I do now?” Most people don’t realize that credit is like a muscle. To achieve a high credit rating, you must use it often, and at the same time, avoid over-using it.
Using credit and having a good credit score are just as important for affluent people as anyone else, and having excellent credit comes with a number of benefits. Credit cards are safer than carrying a lot of cash, can be extremely helpful in an emergency, and are convenient to use when traveling abroad or shopping online. Yet, sometimes it’s not until someone with plenty of assets wants to start a business or buy a vacation home when they realize that neglecting their credit profile for years has a price.
The ins and outs of credit can be confusing, even for those who understand money and investing. One common misconception I’ve seen many affluent people believe is that having ample liquid assets or a large income automatically translate to an excellent credit score. In fact, these have no relationship to your credit score. I’ve also noticed that not all clients use credit to their best advantage.
My colleagues and I regularly educate clients and their children about how credit works. I usually begin by explaining the credit score: What it is and how it potentially affects access to money. Then I share mistakes wealthy people often make with credit.
The FICO® credit score is a number that represents your creditworthiness, in other words, the likelihood you will pay your bills on time. Many lenders use the FICO score to help them decide if a borrower qualifies for financing, and at what interest rate and dollar limit.
Your number is based upon a statistical analysis of your credit files. This information about you is collected and analyzed by three major credit bureaus: Experian, TransUnion and Equifax. Each one uses credit data slightly differently.
FICO scores range from 300 to 850 points. In 2015, about 38% of the population had a score of 750 or more, 40% sat between 600 and 749, and 22% scored less than 600, according to Fair Issac Corp., which created the FICO score.
Here’s how the score breaks down:
Notice that your income and net worth in no way influence your credit score.
While you’ve always been able to get a copy of your credit report by contacting a credit bureau, it once was difficult to get your FICO score until you actually applied for credit. Nowadays, many financial websites, banks and insurance companies make your score available for free at any time.
To maintain a high credit score, avoid these 10 credit traps affluent people commonly make:
1. Underusing credit and loans
The idea of borrowing money is like swallowing poison to some of the wealthiest people who have plenty of cash available to cover their spending needs. But since a big chunk of your credit score is determined by your credit history, not using credit typically results in a lower score, which makes it harder to get credit when you need it — for example, a home, investment or business.
Even if you abhor carrying debt, use a credit card at least once a year and pay off the balance immediately.
2. Overusing credit cards
The reverse can also be a problem: Using credit cards excessively and running high balances. Consumers who charge large amounts on their credit cards, even if they pay them off monthly, run a high risk of damaging their credit.
Remember, the amount of debt you have at the time a lender looks at your report determines 30% of your score. The factor is called the “debt utilization ratio.” This is the amount of debt you are taking on compared to the amount of credit you have. When you use more than 10% of your credit limit, you start damaging your credit score. For example, if you have a $50,000 credit limit on a card, charging more than $5,000 will affect your credit rating. Going over 50% utilization can drop your credit score by 100 points!
So, be mindful of how much you’re charging every month relative to your credit limit… especially if you’re someone who likes to use credit cards for nearly all of your spending needs… and look for opportunities to get your credit card limit increased over time.
3. Not paying proper attention to your bills
Wealthy individuals often lead very busy lives. Demands on time and traveling for extended periods can lead to overlooking due dates or making payments out of the wrong accounts, resulting in bounced checks. Both of these mistakes can have a devastating impact on your credit score and take a long period of time to repair.
Consider setting up autopay so payments aren’t missed. Another option is to hire a professional bookkeeper or financial advisor to manage your bills.
4. Ignoring your credit profile
If you’re like most people, you may avoid checking your credit reports regularly, thinking it simply isn’t that important in the greater scheme of your financial matters. But, it’s important to check your credit reports at least once a year to make sure they are accurate. Credit reports sometimes contain mistakes, identity theft is a growing problem, and people with similar names can sometimes end up in your report. You can easily obtain reports from all three credit agencies at www.annualcreditreport.com.
5. Thinking income affects credit
Remember, credit scores don’t reflect your wealth. While a lender may consider your income or wealth when deciding how much to lend you, your credit score itself is based upon how responsibly you manage your financial accounts. It doesn’t matter how much money you have if your score implies you are a poor risk.
6. Business card blunders
Business credit cards can be an excellent way to track spending and earn rewards for your business. Keep in mind, though, that these accounts are typically given to individuals, not businesses. In other words, mistakes made on the business account will be reflected upon your personal credit report. And a business card with a high balance may damage your credit score.
7. Not using your great credit to get the best deals
A high credit score can be an incredible negotiation tool. Always check your FICO scores before a major purchase to see exactly where you stand. You may be able to reduce rates on mortgages, business loans, auto loans, credit cards and insurance policies by leveraging your credit score. Go in with a high credit rating, and you’ll be more likely to get the best deal possible.
And, if you are part of the affluent consumer group who use credit cards a lot and have good credit, the credit card industry has developed products catering to you. For a higher annual fee, holders of these elite cards get extraordinary perks, including high credit limits and special treatment when they shop. See the fathom post my colleague, Tom Tracy, recently wrote about the advantages of a few cards geared toward travelers.
8. Reward point seduction
Frequently obtaining new credit cards to take advantage of reward point programs or other offers, and then closing the card when the reward opportunity diminishes or ends, flies in the face of maintaining a long credit history (15% of your credit score). While having the appropriate credit card in place for your needs is important, aim to minimize opening and closing credit accounts on a regular basis.
9. Giving up your credit card when you get married
The credit card guidelines mentioned above continue throughout your life, whether you’re married or not. It’s often convenient for married couples to use joint credit cards where one spouse is the primary borrower. If this is your situation, make sure you and your spouse are regularly using credit cards issued to each of you as borrowers so that both of you continue to maintain strong credit scores individually. Although it’s not something anyone wants to think about, it’s important that each of you has strong credit in the event of death or divorce.
10. Helping your kids establish their own credit
It’s natural to want to help your child establish their credit as early as possible. However, be aware that you may end up doing more harm than good if your child is not willing to take care and be responsible for their accounts. As mentioned above, maxing out credit cards and carrying a substantial balance from month to month, plus late payments, will result in lower scores. If you are a co-signer on a card or loan, it could hurt you as much as it hurts them.
If your child is not ready or willing to take the responsibilities seriously, consider making their card payments yourself, or lock their cards away until they are able to prove to you that they are ready.
Even if you don’t need credit, having an excellent credit score can benefit you in many ways. Make sure you have a strong credit profile by using credit regularly, and responsibly. If you happen to currently have a low credit score… avoid the traps above, and within three to six months you should see your score begin to improve.
FICO is a registered trademark of Fair Isaac Corporation.
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