5 credit lessons I wish were taught in school
Credit is one of those many personal finance topics that should be taught in school. Unfortunately, I had to learn about credit the hard way.
I'll never forget when I went to purchase my first "grown up car". I knew what car I wanted and saved up the down payment. I figured my credit score would be good since I usually paid my bills on time. Boy, was I wrong! Ultimately, it related to not understanding how my credit score was calculated. Thankfully, with a little dedication, I was able to raise my credit score over 150 points!
Check out these 5 credit lessons I wish were taught in school.
The credit utilization ratio is the amount of outstanding balances on all credit cards divided by the sum of each credit cards limit, expressed as a percentage. Credit card issuers like to see this amount 35% or less. For example, say you have 2 credit cards:
Credit Card 1: Available Credit $5000, Balance $1000
Credit Card 2: Available Credit $2000, Balance $500
Credit Card 3: Available Credit $3000, Balance $1000
In that situation, you would have a total available credit of $10,000 and a total balance of $2,500. Therefore, your credit utilization ratio would be 25%.
When I originally applied for the car loan, I only had one credit card with an available credit limit of $800 and it had a balance of $700! Therefore, my credit utilization ratio was an enormous 87%. In hindsight, if I know how my credit score was calculated I could have easily paid that credit card down to have an acceptable credit utilization ratio.
Related: Crash Course in your Credit Report
Your credit limit is the total amount the bank or lender has extended to you to borrow. Yes, borrow. Even though a bank may provide you with a credit card of $1000, they don't want you to use the total limit. Using the total limit makes it look like you are overextended financially.
On the flip side, if you can handle credit responsibly, your credit card issuer could provide you with a credit card limit increase. I love credit limit increases but I will say be very careful with them. An increase in the credit limit gives you more to spend but that doesn't mean you need to use it. The reason I like credit limit increases is because it can give your credit utilization a burst.
Original Credit Card Limit: $1000 Credit Card Balance: $300 Utilization ratio: 30%
Increased Credit Card Limit $2000 Credit Card Balance $300 Utilization ratio: 15%
In the above example, a credit card limit increase would drastically lower the credit utilization ratio!
Decreasing Interest Rate
Did you know that you can reduce the interest rate on your credit card? According to this USNews article, about 2/3rds of people that request a reduction in their interest rate are approved! A reduction in your interest rate can save you hundreds if not thousands of money in interest.
The most important step in decreasing your interest rate is that you ask. Come prepared with research when you ask. For example, I might say, "I have received multiple credit card offers with an APR of 10%. I would love to stay with your organization but I just can't justify the higher interest rate. What can you do about it?" Don't be afraid to speak with a manager or supervisor to plead your case.
Related: 6 Bills you Need to Negotiate
Credit cards can be tricky – making sure you only charge things that you can afford and keeping your debt to credit ratio under 30%. However, credit cards have one major perk that many debit cards do not carry and that is fraud liability. Federal law guarantees that the card holder has zero liability. Therefore, if you can use credit responsibly there is definitely a piece of mind knowing that if you are a victim of fraud it will be taken care.
When you receive a new credit card application, there is typically a laundry list of disclosures which include fees. Do you read them? Honestly, I did not read those fees at first. Before you decide that a credit card is right for you, please make sure to make sure you read the fee disclosure. Some of those fees include:
- Annual Fees
- Late Payment Fees
- Balance Transfer Fees
- Foreign Transaction Fees
- Over the Limit Fees
- Returned Payment Fees
- Cash Advance Fees (not that you should EVER take a cash advance)
Personally, I hate hate hate annual fees, but some of the best travel reward credit cards have hefty annual fees. It is most important that you are aware of the fee prior to signing up. Although I have heard some travel hacking geniuses manage to get certain fees waived, I wouldn't count on having their same luck.
Bonus Lesson: Points
Warning: This is the bonus lesson. Prior to travel hacking and truly taking advantage of credit card points, ensure that you pay your high-interest credit card balances down. Points are great but the interest rate associated with a credit card balance is much more expensive than points. In addition, to be approved for the best credit cards available make sure you have worked to raise your credit score.
If you have been following Financially Fit & Fab for some time, then you know besides educating the community about personal finance, I love to travel hack. For example, that time when I used credit card points to pay for the majority of my flight to the Dominican Republic. The bonus lesson that I wish I learned about credit is that credit card points are like free money! Make sure you find a credit card that works for you! For example, I look for credit cards with long introductory periods of no interest as well as no annual fee. After those criteria are met, I look for the card that will supply me with the best points program!
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