November, 2011

Holiday Shopping & Credit

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During the holiday season most consumers take advantage of the discounts offered when opening a store credit card and transferring debt to low interest rate credit card offers. This makes perfect sense if all we consider is the amount of money being saved through the discounts or lowered interest rate. Taking advantage of these savings might prove to be a great benefit to future savings, or on the other hand, a much more costly event than a consumer might expect.

When it comes to credit decisions, timing is essential. Developing a strategy could ultimately save consumers hundreds of thousands, if not millions, depending on its size over the life of that loan.

For example:

Sally is 23 years old and works as a graphic design artist in the magazine industry. Sally's credit includes the accounts listed below:

Macy's Card-- limit $1500 and a balance of $950

Amex Card - high balance of $1200 and a balance of $400

Since borrowers have so much control over revolving credit, the balance to limit ratios will have a big affect on her credit scores. Because Sally's Amex Card does not show a limit, the Fico score will use the highest balance, $1200, as the limit when calculating the credit score.

Her aggregate limit is $2700 with an aggregate balance of $1350 leaving her at over 50% balance to limit ratio. Since being over a 10% balance to limit ratio decreases scores, Sally's score has dropped; the higher the balance to limit ratio, the lower the score. Right now, Sally has young credit since her two existing credit cards are not fully 3 years old and her current Fico score is a 665.

Since Sally does not plan on buying a property or getting financing in the next 3+ years it is a perfect time for her to start building more credit and higher limits to help increase her score. By doing so and managing her credit correctly from now until the time she needs financing, will allow her the best rates possible when she plans to buy a property in the next 4-5 years.

Sally is now getting ready to do some Christmas shopping and decides since she has a gift certificate to Lord and Taylor that she will do most of her buying there. Once Sally finds the merchandise she needs she brings it to the nearest register. As the cashier rings up her purchases and deducts the gift certificate she asks Sally if she would like to save 30% on the $300 balance by opening a Lord & Taylor store card. Sally immediately agrees since she will save $90 and can pay the rest off over the next three months. Satisfied with her transaction she leaves the store happy.

She made a good choice in this situation as she needs to build more credit anyway and the card she just opened will be useful.

However, there is an alternative strategy to consider that might have gained her an additional 40-50 points by the time she is ready to apply for a loan. Those extra 40-50 points could wind up saving her close to $170,000 over the life of the loan.

Here is what I would have done if I was Sally:

Besides the L&T card, Sally received another option for new credit in the form of a pre-approved Master Card at a 4% interest rate initial offer on balance transfers up to $4000 for the next six months. If she applied for both credit cards at the same time she would have had a better chance of being approved since neither would know about the other application. New credit can take a little time to update on the credit profile giving Sally the opportunity to open both accounts at the same time. If the L&T card was opened just a month or two before the application for the Master Card she might have been declined the account due to the drop in score the new credit update would have caused.

Additionally, the L&T card was only offering a $500 limit which might have taken years to increase to a $2000 limit, whereas the Master Card was offering an instant $4000 limit. By having both these accounts, Sally's aggregate limit would increase to a much higher $6200 on her credit, leaving more leeway to have a higher balance without killing her credit score.

These two accounts would allow Sally more options for credit use, of creditors proving she can manage multiple accounts, and the added fact of dropping her score at the same time rather than have the impact of the second account hurt her credit again in the future, will all aid in improving her score. Furthermore, since the older the average age of credit the better it is for a credit score, as these two accounts age, her score will increase as well. She is also insuring that she has many primary accounts which banks want to see when they are lending money.

Sally is therefore using a strategy to get the most out of the credit system for future savings rather than randomly reacting to a creditor's momentary seductive discount offer. With the new credit and 2-3 years time Sally can definitely achieve a 740 Fico score. This could mean a savings of $500 a month on a $600,000 mortgage payment with a total savings of about $170,000 throughout the thirty year loan.

Another example:

John, a successful entrepreneur, has decided he wants to buy a condo in NYC within the next 12 months. Since interest rates are low, rents are high, and his business is doing well it seems like the perfect time. His current credit score is a 760 giving him great options for the best interest rate choices.

John is doing some Christmas shopping for his girlfriend at Saks Fifth Ave. He rarely shops there for himself but he knows it is her favorite store. His purchase totals $2500 and he is offered a 30% discount for opening a new account at the register. With a savings of $750, it is a no brainer and he accepts. Little does he realize that the $750 will cost him the loan he will need to purchase the condo.

With a 760 credit score it is possible he can lose 40-60 points for opening new credit. Since the $1,000,000 loan he wants requires a minimum score of 740 he will not be able to get approval. John will now have to wait two years until his new credit becomes seasoned and his score increases back above a 740 in order to reapply for the loan. Not only by that point could rates be higher, but he will also have to waste 24 months of rent payments. If John had known the true cost of saving the $750 he would have willingly declined the Saks card offer.

These examples were used to show how credit can make or break one of the largest investments most of us will ever make. Since credit is so important to future savings, all of us should be using strategy when taking actions and making credit decisions that can affect our long term goals.

North Shore Advisory offers credit repair and restoration services.
We've been providing credit education and credit improvement for more
than 20 years. We can help you with your business credit needs or
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Email: info@northshoreadvisory.com

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