When your credit score is down, it takes great effort to rebuild it. You have to take care to pay down your debts and get your finances in order. You may also have to change some of your spending habits to have the greatest impact. Consider these five spending habits to avoid that will slow your credit rebuilding efforts.
1. Going Back To Cash
It could be argued that letting the plastic cool off by using more cash is a responsible money management decision. But while it may help you stay under budget, cash doesn't give lenders any way to assess your creditworthiness. There is no payback to monitor because there is no lending involved.
As Millennial Money Expert Stefanie O'Connell notes: "If you are not borrowing money and you have no history of borrowing money, then you have no credit. That means not being able to be approved for the mortgage or the auto loan or the personal loan... whatever it is in the future."
2. Using Debit Cards Or Prepaid Cards
The same principle applies here as it does with cash. Debit cards simply draw money out of your linked account to cover purchases. Prepaid cards act in the same fashion since money has been deposited to cover any potential purchases.
3. Spending Near Your Credit Limit
It's important to control your spending in order to rebuild your credit, but it's especially important to keep your spending well below your credit limit. The amount of credit in use relative to your total credit limit, known as your credit utilization, should stay as low as possible (30 percent maximum is a good rule of thumb). Otherwise, your credit score will drop as a result. Potential lenders interpret high credit utilization as a sign of increased lending risk.
4. Taking Out Payday Loans
Payday loans may be loans, but they don't help to rebuild your credit score. These lenders do not report your payment activity to the three major credit bureaus, so even handling them well won't help rebuild your credit.
Even if payday loans were reported, there would be little benefit in doing so because they don't show responsible credit behavior. Payday loans are secured by writing a check for the repayment amount or providing electronic access to your account. Effectively you are backing your own loan against future deposits.
5. Using "Buy Here, Pay Here" Auto Loans
These are similar to payday loans in that they are higher-interest alternatives for those who can't get traditional financing. In this case, your auto dealer also acts as the finance company. Typically, "Buy Here, Pay Here" dealers do not report your activity to the credit bureaus. If you are considering taking out one of these loans, be sure to secure proof in writing that they will report your payment activity in order to get the credit-building effect.
These last two categories aren't just unhelpful for building credit, they can actually be dangerous. Defaults on payday or "Buy Here, Pay Here" loans may not be reported by the lender, but once the debt is transferred over to a collection agency, the default will be reflected on your credit report.
Be skeptical of anyone who says that they can quickly rebuild your credit score. In reality, rebuilding credit takes time, diligence and a solid plan. That plan includes not only controlling spending in general, but also applying your necessary spending in ways that show lenders that you are responsible with credit. You want to demonstrate that other lenders are willing to lend you money because you now represent a lower risk of default.
Sean McQuay, former Credit and Banking Expert at NerdWallet, summarizes the issue, pointing out that creditors "are not even asking 'Are you financially responsible?'... They are asking, 'Can you handle other people's money effectively?' In order to do that you need to take out debt." Talk or promises will get you nowhere with potential lenders. They want to see tangible proof that you can handle credit wisely, and it's up to you to provide that evidence if you want to rebuild your damaged credit.
Credit cards can be an effective way to manage money, improve credit, earn points, and travel with perks if used the right way. Check out Benzinga's tips and tools for using credit cards effectively, curated by our team of personal finance experts.
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