Your credit history plays more of a role than you may realize in determining how quickly you reach Financial Freedom. If nothing else, great credit can save you hundreds of thousands of dollars in interest payments over your lifetime. Think how much faster you’ll power up your Freedom Generator if that extra money is lining your pockets instead of your creditors’.
With Australia on the verge of introducing U.S.-style credit ratings, the trend toward using credit to determine your future is only increasing. Here are five mistakes you may be making with your credit that are secretly undermining your Financial Freedom:
1. You Don’t Value Good Credit
Maintaining a lifestyle built on debt is fundamentally incompatible with achieving a life of Financial Freedom. However, if you’ve recently committed to living a debt-free life in pursuit of your Freedom, you may think your poor credit choices from the past will stay hidden there.
But good credit isn’t just something you need if you want to apply for more credit. Here are a few reasons you should clean up your past mistakes and make responsible decisions around whatever credit you are currently using:
- Bad credit can mean higher insurance premiums. An increasing number of auto, home and renters insurance companies require substantial surcharges for policyholders with poor credit.
- You might pay more for housing. You know a lousy credit score gives you less favorable lending terms with a traditional mortgage. But you can still run into trouble if you’re looking to rent while saving to pay cash for a house. Credit checks are a routine component of the rental application process, and bad credit can prevent you from landing your cozy dream apartment.
- A history of mishandling personal finances can stall your job search. While no employer can see your actual credit score, some businesses worry that a high-level manager with a history of bad financial decisions is at higher risk for committing fraud, mishandling customer funds or making irresponsible financial choices at the office. So if a history of mismanaging your personal money shows up on your credit report, you may have a more difficult time securing that great job or moving ahead in your career.
2. You Pay Late
Your FICO score—one of the most popular credit scores around—uses payment history as the number one factor in calculating your credit score. In fact, how timely you are with your bill payments accounts for a full 35% of your score.
As a result, even a single late payment can cause your score to plummet up to 100 points. So put systems in place that keep you from falling behind on your bills. That’s why the MindShift.money method is to Automate your finances. It’s just another way of Protecting Yourself and your financial future.
3. You Overuse Your Available Credit
Think you’re in good shape if you’re just shy of maxing out your credit cards? Think again. A major component of your credit score is what’s called your credit utilization ratio—a measure of how much of your total limit you actually use. Studies have found that people with excellent credit scores—800 and above—actually use only about 7% of their available credit. (Keep in mind we’re not talking about how much of a balance they carry but rather how much they spend during the month.)
So how can you easily improve your credit utilization ratio? There are two ways to do it:
- Reduce your spending on credit. Pay through another means, or spend less overall.
- Increase the amount of credit you have. Ask your card issuer to up your spending limit . . . and then don’t touch that extra cash! Many card companies allow you to bump up your limit periodically via an online form.
4. You Carry A Balance
One of the most frustrating ways to part with your hard-earned money is to use it to pay interest to support an unrealistic lifestyle. After all, wouldn’t you rather be earning interest on that money instead of paying interest with it?
Using credit wisely requires you to remember this: Your credit card represents money you have—not money you’d like to have. So it’s critical that you think of your cards as a means to access the available cash you have and not as a magical source of funds.
If you keep that principle in mind, you should always have enough money at the end of your billing cycle to pay off the full amount on your card’s statement and keep yourself from racking up additional debt from interest.
5. You Don’t Keep An Eye On Your Credit
Closing your eyes and crossing your fingers is a terrible way to attain or maintain excellent credit. Instead, track your credit health regularly with some easy, free methods:
- Review your statements carefully. Before you pay a credit card bill, check all the charges and payments listed. Immediately contest anything that’s incorrect.
- Order your credit reports religiously. U.S. citizens have the ability to access three free credit reports every single year, and Australians can get theirs once a year or under special circumstances. Again, dispute inaccuracies and flag fraud.
- Watch your credit score. While you can order your score for a fee, many credit card companies now print your credit score directly on your monthly statement at no cost to you.
Community Question: What’s the biggest mistake you’ve ever made with your credit? What’s your advice for someone who’s making that mistake right now? Share your story in the Financial Foundations community!
image credit: Bigstock/dolgachov
Dr. Tony is the co-founder of MindShift.money and the best-selling author of three books on personal and business finances. Having achieved Financial Freedom at 27, Dr. Tony believes that through Financially Fit Bootcamp and Cash Flow Cure everyone can get there. He has made it his life’s mission to help others live a life where their money works for them—not the other way around.