It’s easy to overlook the importance of your credit history and scores. But it's dangerous to ignore them. Here are 6 essentials to keep in mind.
If you hardly glance at your account statements, remember just in the nick of time to send off minimum payments and can't truly say you have a firm grasp on your future financial goals, it's time to ask yourself some tough questions about your credit.
"People need to understand that their finances impact their quality of life. It can affect your relationships -- money struggles are often a cause of divorce -- not to mention that financial stresses can affect productivity at work or even take its toll on your health," says Denise Winston, author of "Money Starts Here! Your Practical Guide to Survive and Thrive in Any Economy." That's why, she says, it's worthwhile to spend the time to keep your finances in focus.
Need help in focusing? Ask yourself these six crucial credit questions.
1. How much do I owe?
You need to have a handle on all of your debt in order to stay in control of it and put a pay-off plan in place. "It's important to keep an eye on your total balances," says accountant and National CPA Financial Literacy Commission member Kelley C. Long. "From an emotional perspective, it's so you can keep yourself in check. And from a practical standpoint, you don't want to go over your limit and be charged any fees."
Remember, debt includes not only revolving balances such as credit cards, but also car loans, personal loans, home mortgages and any debt owed to family and friends. Winston recommends charting out all of those items at least once per year, if not more often. "Stacking it up and looking at it, and taking the time to run those numbers gives you a clear picture of exactly what your financial debt burden is," she says.
2. What is my debt costing me?
Beyond your balances owed, Long recommends looking at all of your statements, and adding up the total amount of interest you accrue in a given month. "Seeing that number can be a boost of motivation to stick to those goals you set," she says.
Mathematically, it makes the most financial sense to work toward paying off your highest interest account first, says Long. "While paying the minimum on lower interest accounts, pay as much as possible on the highest interest rate account until it's paid off. Then you can move to the next highest, and so on," she says.
Another option is the "debt snowball" plan, made popular by financial author Dave Ramsey, in which you pay off the lowest balance first. "Some people want to feel a sense of accomplishment quicker and faster, so they like the motivation of paying the smallest debt off first," says Ornella Grosz, author of "Moneylicious: A Financial Clue for Generation Y."
Whichever route you take, stick to it, and you'll whittle the amount of monthly interest you pay.
3. How much of my income goes toward debt?
The rule of thumb used by banking institutions when they evaluate potential borrowers is that your total debt payments (including your home loan, car payments, student loans, credit cards, etc.) should not exceed 36% of your monthly gross earnings, says Long. "The most useful way to use that number is if you're considering taking on more debt. You want to make sure you're not overextending yourself," she says.
And, if you're approaching or exceeding that number, take it as a sign you need to buckle down with a serious debt reduction plan.
4. Do I have a healthy credit mix?
Not all credit is created equal in the eyes of potential lenders and the credit bureaus. In fact, 10% of your credit score is based on the mix of credit you carry. Lenders want to see you can handle different types of credit -- mortgages, auto loans, credit cards -- and you should watch your credit mix as well.
"Debt that is used to acquire something that will last longer than it will take to pay for it is generally considered 'good' debt. For example, in theory, students loans are good debt because you'll earn income for longer than it will take to pay off," Long says.
On the other hand, carrying a high credit card balance resulting from pricey restaurant meals and retail splurges isn't viewed as the most responsible way to utilize credit.
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