For many retailers, the holiday season is the first time during the year when they become profitable. For consumers on the other hand, the holidays often lead to excessive spending and burgeoning levels of debt.
A survey conducted by Harris Interactive found that 57 percent of U.S. adults with children said they would be willing to take on higher levels of debt in order to make their children happy for the holidays. Additionally, 60 percent of consumers rollover their credit card balances from month to month racking up serious finance charges. As a result, credit counselors and debt consolidation agencies typically see a 25 percent increase in business during the month of January as consumers deal with their holiday spending hangover.
Unfortunately, too many consumers end up mishandling their debt, causing significant damage to their credit score and their financial position. Since your credit score will have an impact on everything from mortgages and auto loans to background checks and renting a home, an awareness of the following credit score issues can help minimize damage this holiday season.
Of all the variables that affect your credit score, payment history has the single largest impact with more than 35 percent of your credit score determined by this factor. For this reason, late payments on everything from credit cards and mortgages to medical bills and student loans will negatively impact your credit. Even delinquencies to the IRS for tax payments can have long-standing effects.
While missing a payment or two can hurt your score, choosing not to pay at all can really leave a blemish. Having an account charged off by a creditor because they do not believe they can collect, real estate short sales and home foreclosures will all leave long-lasting effects. However, choosing bankruptcy will leave up to a 10-year blemish on your credit report, limiting your ability to obtain cost-effective loans in the future. Bottom line — pay very close attention to your payment history and do your best to pay on time while pro-actively communicating with creditors if you have any issues.
The next most significant credit score determinant is amounts owed, which accounts for 30 percent. Generally the more you owe the lower your score. This is because carrying high balances will increase your credit utilization rate, resulting in a reduction in your score. For example, if you have $5,000 in available credit and currently owe $4,750 on your credit cards, your utilization rate is 95 percent. Also keep in mind that closing out open lines of credit can also hurt your credit utilization rate. Be careful when deciding when and which accounts to close. Additionally, be careful co-signing loans for children or other relatives.
The next 15 percent of your credit score is based upon the length of credit history. Younger consumers who have yet to develop a solid credit history can expect to be dinged in this category. Remember, credit agencies use the length of time you have demonstrated you can pay your bills on time in order to assess your credit risk.
New credit requested/inquiries will also have an impact, accounting for 10 percent of score. How many times this holiday season have you heard retailers say “Would you like to open a credit card with us and earn an additional 10 percent off your purchase today?” Avoid the temptation — opening new credit cards to earn discounts can really hurt your credit score over time. Creditors view too many open lines of credit as a higher risk, possibly resulting in lower scores. Also, keep in mind that allowing multiple auto dealers or mortgage companies to review your credit while you shop around can also lead to a reduced score.
Finally, the last 10 percent of your credit score is based on the type of credit used. While demonstrating an ability to handle installment loans is critical, a solid payment history while utilizing secured, unsecured and also installment debt may also lead to higher scores.
Getting through the holiday season without incurring substantial debt is no easy task. However, managing your debt responsibly will help reduce the significant negative long-term effects it can have. In order to get a better handle of your debt, consider requesting your credit report and score at least once per year while reviewing and monitoring it for accuracy. Consider visiting www.myfico.com for more information. Since everyone’s financial situation is unique, consider speaking to your financial and legal adviser to determine the most appropriate approach for you.
Kurt J. Rossi, MBA, is a certified financial planner practitioner and wealth adviser. He can be reached for questions at (732) 280-7550, kurt.rossi@Independentwm.com or www.Independentwm.com. LPL Financial Member FINRA/SIPC.