Using a variety of types of credit can boost your FICO score, but are you leaning on credit too much?
That’s a question many consumers are likely facing as balances begin to creep up again post-recession. Although total outstanding credit (revolving debt, including credit cards, plus non-revolving debt, including student loans), dropped significantly amid the financial crisis, it’s now about $200 billion higher than it was pre-recession, according to the Federal Reserve.
That’s a load consumers struggle to carry. In a September 2012 National Foundation of Credit Counseling (NFCC) survey, 46 percent of approximately 2,000 respondents said their lifestyles would take a hit if they had to live without credit. Twenty-two percent said that they would be unable to make ends meet without credit, while 24 percent said they would have to make significant changes to their lifestyles if they were to live on a cash basis.
“Credit is a useful tool,” says NFCC spokeswoman Gail Cunningham in an email. “However, even in more recent times, many consumers are using credit to support a lifestyle beyond what their income can support.”
It’s not always obvious when your debt officially enters the danger zone. Yet there are five warning signs you can pick up on, long before collectors start calling.
1. Your credit card balances are slowly inching up. A key sign of healthy credit usage is paying off credit card balances in full each month. If your credit card balances keep climbing up every month, it’s a warning sign that you may be living beyond your means. If it’s a temporary phenomenon, it’s not a big deal. But if this happens consistently month after month, it’s only a matter of time before you run into trouble.
“This should be a wake-up call for consumers,” says Cunningham. ”For one thing, if they are employed and could not make ends meet without access to credit, what would happen if they lost their job?”
2. You find yourself shuffling around your debt. If you have to pay some bills late in order to meet your credit obligations, it’s a clear sign of trouble. The same goes for taking out cash advances, using multiple balance transfers in rapid succession and opening new lines of credit to get extra cash.
3. You’re avoiding your debt. If you simply pay the bills each month without bothering to total up all your outstanding debt, it could be a sign that you’re in denial about your debt load. Having no idea how long it will take to pay off your debt and having no plan in place to do so are other symptoms of debt-avoidance.
Other signs of denial? Your spouse has developed an annoying habit of nagging you about your spending, and you have frequent arguments about money. You put off visits to the doctor or dentist or mechanic, because they will generate bills you can’t afford.
4. You’d go under water if you lost your job. You may be paying your bills every month without a problem. However, if the thought of what would happen if you lost your job makes the blood drain from your face, you have likely taken on too many financial obligations. If your current credit usage prevents you from putting money aside in a savings account to cover your debt payments for six months or longer, you are setting yourself up for trouble.
5. Your debt payments eat up too much of your income. A general rule of thumb is that monthly payments on all your debts, including mortgage (or rent) payments, should be below 36 percent of your income.
Total the monthly payments on credit cards, mortgage (or rent), car loans, student loans and any other credit lines or loans you may have. For credit cards, don’t just factor in the minimum payment due, but the amount it would take to pay the balance off within a reasonable amount of time (about two to three years).
Then divide the total debt payments by your monthly income to find your debt-to-income ratio. If the ratio is less than 36 percent, you’re in good shape. For debt ratios significantly above that, it may be time to consider getting help from a professional credit counselor.