How to Build Your Credit Responsibly

If you have a new credit card, one reason you might have gotten it is so that you can use it to finance purchases you might otherwise have had a hard time making. You may also have secured the card to help you rebuild your credit standing.

If that’s the case, there are a few things you should know about how to manage that account to boost your score as quickly as possible. Perhaps the most important thing is to only use your card for payments that you don’t make every day. Putting lunch or a cup of coffee on your credit card might get you into bad spending habits and cause you to put more debt onto the card than you can reasonably afford. In fact, you might want to consider only spending as much on the card as you can pay back every month to keep yourself headed in the right direction.

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Along those same lines, if you do end up racking up more debt than you can pay back in a single month, it’s important that you at least pay back more than the minimum. Again, this is to ensure that you don’t get into bad habits, because only paying the minimum every month will keep you in debt much longer than you’d probably like.

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As a general rule of thumb, you should try to keep your debt to 10 percent or less of your card’s total credit limit. That’s because 30 percent of your credit rating is based on just the amount of credit you use at any given time, and the less you utilize, the better. There is a myth that lenders want you to have at least some debt outstanding all the time, but it’s not true; the closer your balance is to zero, the better off you’ll be both financially and in terms of a maintaining a strong credit rating.

Of course, when you’re opening a new credit card account, you should take a look at all the ways in which it might affect your finances. Consider things like whether you’re able to make all the payments you need to—on time and in full—as well as if it might affect your ability to pay other bills.

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How Much Do Inquiries Affect Your Credit Scores?

How do inquiries affect your credit scores? That’s a question I recently posed to Tom Quinn on my radio show Talk Credit Radio. Tom’s a credit scoring expert with many years of experience, including helping to develop, launch and grow MyFICO.com. He also contributes to Credit.com’s blog. Here is an excerpt from that interview.

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Gerri:   Fact or fiction? Every time a person applies for credit it costs them 5 points off their credit scores. Is that true or false?

Tom:    That is false.

Gerri:   So what’s the truth about it?

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Tom:    Basically, whenever a lender touches your credit report, or if you’re seeking credit, then they usually will pull your credit report to understand your credit risk, and an inquiry is posted. So there are all these different kinds of inquiries out there.

For example, if you come home today and have a pre-approved credit offer in the mailbox, a lender probably pulled your credit report to do that and then there’s a certain code associated with it that can be identified as a” promotional inquiry”. Or, if you get a message on your credit card statement saying, “because of your great credit behavior we’re raising your credit line,” they probably pulled a credit report to do that as well and then an inquiry will be posted. If you go and try to pull your own credit report at myFICO.com for example, an inquiry is posted.

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So the good news is, all those inquiries are tagged or identified separately so that the model can really isolate those credit inquiries that are related to you seeking credit, when you’ve actually applied for credit. When you apply for credit, what research shows is that people who applied for credit are riskier than people who haven’t.

But the good news is, inquiries don’t cost a whole lot of points in the big scheme of things. How you pay your bills and how you manage your debt is really what’s counted in the score. Inquiries will add a little bit of predictive value on top and may result in a couple points lost here or there. But the way the inquiry logic works, a couple of things: your inquiry is shown on your credit report for the last two years but that model’s only looking at inquiries in the last 11 months. So those a little older than 12 months, for example, aren’t counted.

And there’s a capping logic. Basically, the way the model works, is once you’ve reached a maximum number of inquiries for that particular score card, whether you have one more on top of that or 15 more on top of that, they don’t count extra against the score. So, in the big scheme of things Gerri, inquiries get a lot of attention by consumers but they really don’t cost them a million points. Really focusing in on paying bills on time as well as managing your debt levels is really what’s going to drive the score.

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To listen to my complete interview with Tom, right click on the download link below to open it and play it on your computer or to download it to your mp3 player. It is also posted on iTunes.

Listen to the interview with credit scoring expert Tom Quinn here.

Image: Valerie Everett, via Flickr.com

Is Your Health Insurer Ruining Your Credit?

If you have ever puzzled over a hospital or doctor bill and whether you are supposed to pay it, then join the ranks of millions of Americans equally confused by medical bills. One national study found that 40% of American adults do not understand these bills well enough to know why they owe the outstanding balance or if it is correct.

Other studies, including those by the American Medical Association, have revealed that one of every five claims is inaccurately processed by health insurers. To add to the confusion, many bills from hospitals and doctors arrive months after treatment, further clouding the reason for the bill and the amount due.

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Many people are tempted to wait for clarity. They set the bills aside with the hope that their insurer will pay the claim. This is a big mistake, since delaying payment can result in the medical bill being turned over to a collection agency. Once there, it will likely lead to future headaches.

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300 Billion Reasons to Pay Attention to Your Medical Bills

Total healthcare spending in America amounted to $2.6 trillion in 2010. Of this total, $300 billion was paid out of pocket, for example, through deductibles and co-payment fees. The growth in out of pocket spending accelerated between 2009 and 2010 as more people switched to higher deductible plans or increased co-payments in exchange for lower premium costs.

Paying more up front for healthcare is becoming commonplace for insured patients. But keep in mind; providers want to be paid for their services. When they do not receive prompt payments, they initiate action similar to other businesses and send the bills to collection.

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Once in Collection, Doing the Right Thing is Not Enough

Contrary to what many believe, medical debt can hurt your credit score. Thirty million Americans are contacted annually by collection agencies for unpaid medical bills. Patients frequently claim confusion led them to allow bills to go past the due date or be sent to a collection agency. According to studies published in the Federal Reserve Bulletin, more than half of all collection accounts on credit reports are medical in nature.

Collection agencies routinely report medical bills to the credit bureaus. They view all collection accounts as “delinquent” with no regard for why the bills were sent to collection. Many people, upon hearing from a collection agency, promptly pay the medical bill in full. After doing so, they are often surprised to find that these accounts stay on their credit report.

Medical collection accounts can linger for up to seven years, even with a balance due of ZERO. Collection accounts are reported in the credit history section of a credit report which accounts for 35% of a credit score. Because of this, these fully paid “delinquent” medical bills can sting. One or two recent medical collections can lower a credit score by 50 to 100 points. Such a significant reduction in a score will dramatically increase the cost of a mortgage or the interest rate on a credit card.

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Avoiding Medical Bill Problems

So, if you have an outstanding medical bill, what can be done? First, if you are confused by a medical bill, do not ignore it. Contact the provider immediately to discuss the bill. If you are not certain whether you or your insurer should pay the bill, inform your provider that you are working with your insurance company to get the bill paid. Assure them that you will pay your share. Ask that they refrain from sending the bill to a collection agency while you resolve the issue.

If the bill is large and you need to pay it off over time, again, discuss this with your provider. Doctors and hospitals often allow patients to pay their bills off over many months, even interest free. Some provide financial discounts to income eligible patients. If your hospital or doctor provides a discount or allows you to pay over time, ask them to put the agreement in writing. If they do, be sure to maintain timely payments so that the bills do not end up being sent to collection.

Addressing Medical Bills that were Sent to Collection

If you have a medical bill that has already been sent to collection, first make sure that you are obligated to pay it. Contact the provider and/or the insurer to make sure the insurance company has paid all claims and that the provider has applied all available discounts. Then make arrangements to pay your share and ask the agency to remove it from your report after it is fully paid.

If your medical bill had been inappropriately sent to collection due to confusion on whether you or the insurer was responsible for payment, this is not truly a credit issue. Work with the provider or their third party collection agency and ask that the account be deleted from your credit report once it is paid in full.

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Systemic Change May Require an Act of Congress

Many healthcare providers recognize that bills can be sent to collection in error and may agree to delete them from a credit report. However, they are not necessarily required to so do.

The problem of medical bills ruining people’s credit has come to the attention of the U.S. House of Representatives. Congressmen Heath Shuler (D-NC) and Don Manzullo (R-IL) have put together a sensible bi-partisan proposal to address this problem. They feel that medical debt is unique and that it deserves to be treated differently than other types of debt. So they decided to take action by introducing HR 2086, the Medical Debt Responsibility Act. The legislation requires that medical bills (of less than $2,500) that are fully paid off or settled be removed from a consumer’s credit records within 45 days.

This straightforward proposal does not fix the medical billing system but it provides relief for those who’ve paid off their medical debts. It enjoys support across the political spectrum spanning from Rep. Ron Paul to Rep. Barney Frank and has dozens of co-sponsors. Congress should immediately enact this proposal and protect families from any further financial harm due to medical collections.

Be a Savvy Consumer

Illness or injury can result in hardship and medical bills. Ignoring these bills can create problems. Exercise your consumer protections. Keep tabs on the content of your credit report. Pay your bills. And do not allow confusion around your medical bills to ruin your credit and threaten your financial future.

Image: bolistan, via Flickr.com

Credit.com in the News: Credit Trends, Cards for the Unbanked, Rebuilding Credit

What went on in the week of consumer credit? So glad you asked. In addition to their regular contributions to the Credit.com blog, Credit.com’s credit and debt experts regularly offer their advice and commentary on the state of consumer finance to other media outlets.  For even more great advice and insight, we present to you the highlights from this week’s media appearances:

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Credit Card Bonuses, Drawbacks Await Consumers in 2012

Credit.com co-founder, Adam Levin shares the upcoming trends in credit with Tara Lynn Wagner from NY1. He explains that we’ll be seeing competitive sign-up deals and that credit will become more available, but often at a higher cost.

@NY1Headlines @taralynnwagner

Unbanked? Here Are 4 Secured Cards That Can Boost Your Credit Score

Credit Expert, Beverly Harzog talks the dos and don’ts of secured cards with Jeanine Skowronski from Main Street. Find out which cards may be best for you.

@TheStreet

12 ways to rebuild your credit

Debt guru Gerri Detweiler talks with Susan Tompor for The Herald about the dangers of debt-settlement companies who wait too long to pay large balances on major cards. Consumers beware!

@HeraldNet

How Credit Card Balances Impact Your Score

A reader, Dylan, recently wrote in with a question for us. He has three credit cards and wants to know if it is better (results in higher points) to carry similar balances across all three cards or to carry a large balance on one of his cards and zero or very low balance on the other two cards. 

The exact answer depends on the balance and ratios dynamics on Dylan’s credit cards, as well as his overall credit profile.

[Related Article: 8 Credit Score Myths Debunked]

How you manage your overall level of credit debt is a very important component of your credit score—and how you manage your revolving credit (like your credit cards) is especially important as the score is heavily focused on revolving debt.  Generally speaking, credit scores focus on a consumer’s aggregate revolving utilization percentages or ratios—in other words, how much of their available credit is used.  This is determined by taking the sum of all of your credit card balances as reported on your credit report and dividing that by the sum of the total available credit reported on your credit cards.

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For example, your revolving utilization would be 50% if you have $5,000 in credit card balances and $10,000 in available credit on those credit cards.  The higher the ratio or utilization percentage the less points granted as research show that consumers who carry higher ratios of revolving debt are substantially more at risk of missed payments, compared to people who have lower utilization ratios.

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In addition to total or aggregated revolving utilization, the scores may also consider information such as the number of credit cards reported with a balance greater than $0 and/or the number of credit cards that each have a revolving utilization greater than “X” percent.  A consumer may receive less than optimal points if they have a higher number of credit cards with a balance being reported or may gain points if they have a higher number of credit cards with very low revolving utilization on each card.

By design, the scores are complex and evaluate revolving card usage in several ways to predict future credit risk.  When it comes to managing your revolving credit, the best advice is to make your payments on time and to keep your revolving balances low—this will help to increase your score over time.

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Image: Phil Hawksworth, via Flickr.com

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