07
May

In the last few quarters, consumers have taken the improving economy as a sign that it might now be feasible for them to add to their debt loads once again, and this was particularly true in the first three months of the year. However, those who wish to do so would likely be wise to use extreme caution.

The recent surge in consumer debt during the first quarter of the year shows that consumers are likely feeling far better about their finances and hopes for improving them going forward, as economic recovery continues at its slow, but more or less steady pace. However, the mistakes many may have made during the recent recession and in the years following should also give many borrowers who previously eschewed credit pause when it comes to the new accounts they may be seeking. This is especially true of those people who experienced credit problems themselves during that time, because they may still have significantly diminished credit scores that could need to be more fully fixed before new credit is sought.

What lessons could be taken from the downturn?
The most pervasive problem experienced by many consumers during the downturn was that they likely racked up more debt prior to that time than they could afford to pay back if they ran into job loss or other types of financial distress, and that in turn led to many running into delinquency and default, or otherwise letting their balances only grow more quickly, instead of making more concerted efforts to pay them down in the face of these problems.

Of course, missing payments and carrying too much credit debt are the two biggest mistakes borrowers can make when dealing with debt, as these two factors alone account for 65 percent of one's credit score. The slightly larger of these two issues is payment history, because it makes up 35 percent of one's score, and what many consumers may not realize is that even one missed payment can wipe out months or even years of good, hard work to meet all requirements on time and in full.

Further, the amount of debt being carried on any accounts in a borrower's name, when viewed as a percentage of his or her total available limits, makes up another 30 percent of the score, and this factor is known as "credit utilization ratio." While many consumers may think that lenders want them to carry as much debt as possible, the truth is actually quite the opposite. Financial institutions want borrowers to have as little debt as possible because it decreases their risk in the event that the consumer is no longer able to pay their bills. In fact, those who want to make sure this portion of their credit scores are as healthy as possible should try to keep their balances to just 30 percent or less of their credit limits. For instance, if they are allowed to borrow $10,000 total on their three credit cards, the combined balances on those accounts should not exceed $3,000.

How can borrowers improve their finances now?
While it may seem relatively easy to avoid running into credit trouble when adhering to the above directives, it's also important for borrowers who are now increasing their credit use these days to know about the impact that not repairing credit will likely have on their finances in general. For one thing, while they may be able to obtain new accounts, they will likely pay a heftier price for doing so.

Accounts issued to those with diminished scores will carry higher fees and interest rates that can make them far more difficult to afford than those to which they may have grown accustomed in the past, and that in turn means they will likely run into additional debt more quickly, which can then lead back to additional credit problems and lower scores. That can start the vicious cycle all over again and once again necessitate credit repair efforts.

Another way in which borrowers can do more to protect their credit scores is simple enough: Ordering copies of their credit reports with some amount of frequency, usually a few times a year, will allow them to determine whether there are any unfair markings on these documents that may be dragging down what should otherwise be strong ratings. If any such entries are discovered in the course of checking these reports over, it might be wise for borrowers to get in touch with a credit repair company, which may be able to set these problematic listings to rights and return their scores to where they otherwise deserve to be more quickly than these people might be able to achieve on their own.


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