The Risks In Maxing Out A Credit Card

 

When consumers sign up for credit cards, they understand the many responsibilities that come with owning that card, and what it means for their credit score. Often, when considering a borrower's viability, credit utilization rates are examined, and generally OK'd if they have low to mid rates that demonstrate proper usage. However, despite the strict adherence to best practices in credit, consumers may be led to max out a line for an emergency or other purchase of services or essentials. Low limits may also hinder spending and result in credit score hits, but in some consumers' cases, it's worth it.

 

When to max out, and what to know
USA Today laid out a couple scenarios in which it might be acceptable to max out a credit card. Emergencies are clear situations in which one may need to max out a credit card to pay for medical expenses, home or car repairs and costs of children. If you're running low on cash and are in between jobs, that's another scenario where maxing out a card could be advisable. One not-so-noted situation to max out in is if you're accumulating points and it may pay off sooner if you make large purchases.

While all these situations may be viewed as times when a card should or could be maxed out, it's centrally important to know the risks involved and the actions to take to prevent or undue damage. Such risks include:

• Damaging credit score: Credit utilization accounts for 30 percent of your score, and if your utilization is thrown too far out of whack, your credit score will show a pursuant drop.
• Triggering a penalty fee: Many credit agreements are couched with a statute that holds if the cardowner defaults on a payment because of maxing it out. This penalty fee allows the creditor to increase interest rates to their highest, often 30 percent.
• Impacting future credit availability: A pattern of maxing out is a dangerous habit to gather, and lenders will likely look at it later on, if you seek new lines of credit, with a wary eye. Getting too deep in maxing out may severely restrict credit available to you down the road.

So why max out, and what to do

Given all the penalties and pitfalls laid out above, one may ask why he or she should consider maxing out in the first place at all. The process of building credit throughout your life, maxing out may allow you to not only repair, but improve on credit.

 

How could hurting your score further when it's already low not be counter-productive when trying to rebuild your credit and raise your score? The short answer is that sometimes it's best to take one or two steps back in the short run so you can go further in the long run, and that in credit rebuilding you're running a marathon and not simply around the block. The longer, and more factual, answer follows.

 

The maneuverability a consumer has in maxing out a card lies in the temporary damage it can do. While payment history leaves a multiyear mark on a credit score, credit utilization delivers only a temporary hit if something goes wrong. In that case, it's of the utmost importance for any consumer considering maxing out their card to pay the charges as soon as they are posted to the account, and not leave it to the last moment when the billing cycle ends and you're in debt.

3 Step Guide To Financing Your Dream Home

Get Your Finances In Order & Crunch Your Cash Numbers

The first time you think about becoming a homeowner is the moment you should start financial planning. Read more »

Check Your Credit (and Repair if Needed)

Lenders will carefully check your credit and will rarely approve a loan for someone with seriously bad credit. Read more »

Secure a Home Loan

Between signing a contract and finally getting your keys, follow through to make sure the loan process flows smoothly. Read more »

Boost Your Credit Score

Easy loans for bad credit borrowers were common amid the housing boom in the early 2000s, but they’re now rare.

If you’re interested in buying a home nowadays, lenders will carefully check your credit and rarely will approve a loan for someone with bad credit.

For that reason, it’s important to check your credit report and your credit score.

Many consumers are surprised by their credit score and many find errors on their credit reports. Carefully review your credit report and focus in particular on negative items to see if there are ways you can address them and improve your credit profile and your access to a mortgage.

Boost Your Credit Score

Your Credit Counselor will go over methods to repair your credit and get you a healthy score. We can help in the following areas:

• Collections and judgments can be solved through our Debt Management Plan.
• Pay your bills on time.
• Reduce your credit card debt and pay more than the minimum each month.
• Do not open new lines of credit.
• Do not close your credit card accounts.

Credit Scores, Lenders & Your Credit Counselor

Your Credit Counselor can be a great source of advice about your credit issues and can tell you what minimum credit score is needed for a particular loan program. Different lenders have different loan standards, so while one lender may reject you with a credit score of 640, another could give you a loan approval.

In general, FHA-insured loans have lower credit score requirements than conventional loans. In addition, the FHA has loan programs making it easier for some people who lost a home in a short sale or a foreclosure to get a new mortgage faster.

While FHA loans can be easier to qualify for if you have damaged credit, the downside of this loan program is you must pay mortgage insurance on the loan, usually for the life of the loan. FHA mortgage insurance is typically higher than private mortgage insurance.

Private mortgage insurance also is automatically cancelled when your loan-to-value ratio reaches 78%.

Conventional lenders base their interest rates on your credit score, among other factors, so if your credit score is above 740, you’ll pay a slightly lower interest rate than someone with a credit score of 700.

Lenders look at many factors when evaluating you for a mortgage loan, including your debt-to-income ratio, your income and assets, how much your down payment will be and your job history. These compensating factors can sometimes help you overcome a slightly low credit score, but your best chance for a loan approval is to improve your credit score through our Credit Repair Program. 

Secure Your Homeloan

There are two situations for securing your home loan. Either you already have a credit score of 640 and met the requirements or you had your credit repaired and worked with a counselor to get your credit healthy. Once you have the score lenders are looking for and you've discussed the purchase with a lender, you're not out of the woods yet. 

Until you get to the settlement date and have the keys to your new home in hand, you still need to be vigilant about your finances and keep in touch with your real estate agent, the title company and -most of all- your lender: your home loan may still need attention.

From Pre-approval to Final Approval of the Home Loan

When you consulted a lender and obtained a pre-approval letter for a home loan, you may have thought your loan application was complete -but now that you have a contract, the real application must be processed.

Hopefully, your lender already went through the step of obtaining documentation from you -of your income and assets, bank statements and W2s, and an authorization to request your federal income tax returns. If not, you will need to gather all your financial documents now and provide them as soon as possible to your lender.

Even if your pre-approval included full documentation, you’re likely to need to give a lender updated paperwork such as your latest pay stubs, particularly if your pre-approval was several months ago.

The second part of your loan application depends on an appraisal of the property you are buying. Every lender needs an appraisal to understand the underlying value of the property, which is collateral for your mortgage. It’s up to you to pay for the appraisal but the lender will choose the appraiser.

If the appraisal meets or exceeds the price you have offered for the home, that piece of your loan application is complete; but if the appraisal comes in too low, you will only be allowed to borrow up to the maximum of the appraised value -minus your down payment.

In other words, if the appraiser says the house you want to buy is worth $200,000 and you intend to make a down payment of 10%, the lender will only approve a maximum loan of $180,000. If you and the seller have agreed on a higher price for the home, such as $215,000, you will either need to renegotiate the offer or come up with the extra cash to make up the difference.

Follow Your Lender’s Lead

During the interim period between the signing of the contract and settlement date, you will have several responsibilities to make sure your mortgage is in place when you are ready to close.

• Respond immediately to all lender requests: Lenders often need more information from you while your home loan is being processed. Even if it seems excessive, make sure you provide everything needed in a timely fashion.
• Keep track of all deposits and withdrawals: If you have any unusual deposits other than your paycheck, you will need to provide a paper trail of where the money came from, so it’s best to avoid any major financial moves at this point. If you must move money around for your home purchase, keep excellent records and be ready to provide them to your lender.
• Maintain your credit profile: Don’t apply for new credit, spend anything on your credit cards or close any credit accounts -because any one of these moves could hurt your credit score or change your debt-to-income ratio. Wait until after the closing to make any purchases for your new place.
• Communicate with everyone: Your real estate agent, your title company and your lender should be busy behind the scenes getting ready for settlement day, so you should stay in touch with them often to see if everything is on track -and if they need anything from you.
• Following these simple steps makes it much more likely that your loan will be ready when you are ready to pick up your keys.

Foreclosure or Bankruptcy -Which Option is Worse?

Foreclosure and bankruptcy are both daunting -often the last straw after a long financial struggle. When considering your options, it is important to compare the eventualities and weigh the effects carefully. While both will cause undoubted credit score damage, minimizing the fallout is critical. Despite your current situation, avoid giving in to complacency. Include long-term credit repair as a factor in your decision. In addition, consider:

Urgency

Foreclosure and bankruptcy carry different levels of urgency. Depending on your circumstances, one may be a better fit when compared with the other. For example, what is the status of your mortgage? Have you only missed one payment, or has your situation progressed past the 90-day mark? Depending on the answer, you lender may be willing to help. Before taking any action, contact the bank and explain the circumstances. If your money troubles are temporary, ask for a forbearance period or other option to reestablish your financial stability. Consider taking on a renter to aid you in this goal. If your troubles are more permanent, however, bankruptcy could be your last option.

Long-term issues

Foreclosure and bankruptcy both carry long-term credit consequences. These citations may remain on your credit report for 7 to 10 years. Living with a decade of bad credit can be devastating, especially if you expect to rely on your credit score in the future. A low rating equals high premiums and interest rates, two factors every consumer should try to avoid. If you are nearing the apex of a decision, consider the long-term consequences against your long-term goals. For example, while filing for Chapter 13 bankruptcy is no picnic, a future lender may view it more favorably than a property foreclosure. As the “wage earner’s” option, Chapter 13 illustrates your willingness to repay debts on a restructured scale. On the other hand, foreclosure illustrates little more than walking away from your property. Consider these viewpoints and their creditworthy implications.

Homelessness

If you plan to file for Chapter 7, or total debt elimination, foreclosure could be an inevitable byproduct of your decision. While a “clean” slate may seem tempting, the immediate impact on your living situation is obvious. Foreclosure proceedings generally allow property owners at least three months before eviction, but what happens after the grace period ends? Do you plan to rent an apartment? How will a lower credit score affect your plans? Minimize these risks by:

• Brokering a deal.  

As stated above, work with your lender to restructure payments and avoid credit damage entirely. Foreclosure and bankruptcy are always the last resort.

• Delaying the inevitable.  

If bankruptcy and/or foreclosure is inevitable, ask for some goodwill. Request a delay in the proceedings. This will allow you to stay in your home and find other living arrangements before your credit score takes a nosedive.

• Restructuring your debt.  

For homeowners with considerable equity, giving in to Chapter 13 proceedings is often preferable to losing their investment. If this sounds familiar, use the court’s help at its full potential. While the trustee will restructure your debt, go the extra mile by exceeding their expectations. Take on a part-time job, adopt a new budget, and cut costs to help your cause. The bottom line: While the need for credit repair is certain, financial trouble should never envelope your life. Allow personal motivation to determine your future.