Do Americans Understand the Ins and Outs of Credit? They should. After all, they have had enough. A NerdWallet Study 2015 found that the average American household in debt has credit card debt of $ 15,310 and total debt of $ 132,086.
Financial advisers face many misunderstandings.
“I constantly see people with a lot of confusion about credit and building a positive credit score,” said Jason Reiman, certified financial planner and owner of Get Financially Fit. “The biggest problem I see is that people mistakenly think they have to have so many different types of credit to improve their scores.”
Reiman recommends that customers have a major credit card, paid for in full each month. It uses a schema from MyFico.com to help them understand the factors that most contribute to developing a positive score.
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Many consumers don’t understand the costs of borrowing, said certified financial planner Kathryn Hauer of Wilson David Investment Advisors.
“They don’t run the numbers and see what they’re actually paying over time with credit cards,” she said. “They don’t realize how the costs of credit are constantly changing.”
Customers don’t know they need to keep their overall debt ratio – as well as in every credit account – below 30% of their credit limits, said Paul Stagias, certified financial planner at Francis Financial.
“For example, a customer looking to repair their credit rating planned to bill as close to their limit as possible each month,” he said. “I told him that although he planned to pay off the balance each month, using [a high percentage] of her credit limit would further damage her credit. “
Stagias added that customers are also unaware that they shouldn’t close credit card accounts, but should instead cut and throw away the cards if they find their spending habits getting out of hand.
“Closing an account will reduce the length of their average credit history, which is a key but often overlooked part of their credit health,” Stagias said.
Shawn Tydlaska, CFP, Founder and CEO of Ballast Point Financial Planning, debunked some common misconceptions:
- You must have a balance on your credit card. TThe balance does not affect a credit score, but a good payment history does.
- Checking your credit score will hurt your score. These are just the “hard” surveys [e.g., applying for a new line of credit] that affect credit scores.
- Your income affects your credit score. Income affects the ability to get a new line of credit or a favorable interest rate, not the FICO score.
- Your spouse has good credit, so you don’t have to worry about yours. It is important to improve your own score, especially when applying for a loan where the credit of both spouses is taken into account
- You don’t need a credit card. By not having a credit card, you have no credit payment history.
“In terms of educating my clients about good debt and bad debt, one thing I tell them is that good debt is deductible on your tax return,” Tydlaska said. “For example, interest on student loans and mortgage debt are two types of good debt.
“Bad debts are consumer loans to finance your lifestyle, such as auto loans, personal loans, credit card debt and payday loans,” he added.
Stagias at Francis Financial educates clients about credit both by reviewing their credit reports with them every year and by hosting an event for their children, ages 12 to 30, that discusses the proper use of credit cards, good debt versus bad credit; and other topics.
Wilson’s Hauer David Investment Advisors works with clients to overcome their emotional credit issues.
“They believe you should never have credit,” she said. “There is an underlying guilt that this is a bad thing.
“They also fear another disaster like 2008,” Hauer added. “I see this reaction on all levels.”
This guilt hurts clients in a number of ways, she said, making them feel too embarrassed to seek professional advice. In turn, they postponed the treatment of guilt. They then lose willpower and feel pressured to make quick decisions that result in higher costs.
“I explain to them that a business only grows by raising money, just like a family,” Hauer said.
Reiman of Get Financially Fit also looks after clients’ emotional dispositions to determine if having large debts is causing them anxiety.
“The circumstances of today’s life often dictate a particular attitude towards debt,” he said. “This, of course, can and does change over time depending on what is going on in life.
“Simply put, every individual’s situation is different and they will approach the subject of debt differently,” continued Reiman. “I don’t think there is a general one-size-fits-all approach.
“Instead, I like to focus on what ultimately motivates the client, providing training where it’s needed, and ultimately helping them save unnecessary interest charges in the process.”
– By Deborah Nason, special for CNBC.com