For many retailers, the holiday season is the first time during the year that they become profitable. For consumers on the other hand, the holidays often lead to excessive spending and for some, elevated levels of debt.
According to a recent www.creditcards.com poll, 61 percent of those who carry a credit card balance are willing to add to their debt in order to get through the holidays. Additionally, more than half (52 percent) of millennials surveyed also said they are willing to add to their debt, as opposed to 49 percent of Gen Xers and 34 percent of baby boomers. As a result of the anticipated higher levels of debt, credit counselors and debt consolidation agencies often see a 25 percent increase in business during the month of January as consumers deal with their holiday spending hangover. In some cases, consumers may even end up paying for this year’s holiday gifts for years to come.
Unfortunately, many consumers mishandle 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 for employment 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 credit effects. Additionally, a bankruptcy may leave a blemish on your credit report for 7-10 years depending on which form or chapter is selected, ultimately 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 $10,000 in available credit and currently owe $9,500 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 your 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! Not only can opening new credit cards to earn discounts hurt your credit score, it may also encourage excessive spending 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. You could say diversification also applies to debt too.
Getting through the holiday season without incurring substantial debt is no easy task. Unfortunately, many of us feel pressure to spend excessively to show how much you care about family and friends. However, how many people would encourage a loved one or friend to jeopardize their financial stability for the holidays? While it is often easier said than done, try to avoid incurring extra debt over this holiday season. If you are struggling with debt, managing it 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, CFP®, CRPC®, AIF® is a CERTIFIED FINANCIAL PLANNERtm & Wealth Advisor. He can be reached for questions at 732-280-7550, kurt.rossi@Independentwm.com,www.bringyourfinancestolife.com & www.Independentwm.com. LPL Financial Member FINRA/SIPC.