You probably know that taking on extra debt during the holidays isn’t the best idea. Newly incurred debt can be bad for both your wallet and your credit score.
If you can manage to pay for your holiday purchases without spending more than you’ve already saved up for the purpose, then, by all means, you should do so. However, if you’re definitely going to finance some of your holiday shopping, you should at least try to do so as wisely as possible. Here are some tips to limit the damage to your credit this holiday season.
Consider a Personal Loan
While any new debt has the potential to harm your credit scores, the variety of debt you choose can mitigate your damages. Certain types of debt are worse for your credit than others.
For example, revolving debt (aka credit card debt) can damage your credit scores significantly, even if you make all of your payments on time. Statistics clearly show that people who incur large balances on their credit cards are riskier borrowers than those who don’t. So the strategy, if it works for you, is to avoid this kind of debt by using a personal loan rather than credit cards to pay for holiday purchases.
A personal loan is installment debt – which means you pay it back in defined increments, like a car loan or student loan – which is the key to this strategy. Credit scoring models treat revolving debt very differently than they treat installment debt. A $5,000 personal loan will likely have no negative impact on your credit scores if you pay it back reliably. Conversely, a $5,000 credit card balance, especially if that balance uses up a large portion of your credit card limit, could be viewed very negatively from a credit scoring perspective.
For this reason, given comparable interest rates and other terms, it would almost certainly be better for your credit scores if you took out a personal loan to finance your holiday expenditures instead of taking on new credit card debt for those same purchases.
Map Out a Debt Payoff Plan
If you’re going to take on new debt during the holidays, map out a payoff plan first. Do you plan to wipe out the new debt within three months? Six months? Or longer? If you don’t know the answer to this question, then your holiday purchases are going to cost you considerably more because of the interest you’re going to pay while you carry the debt. Your goal is to determine how much extra you’ll need to pay each month to exhaust your newly acquired debt as quickly as possible.
Even if you intend to pay off the debt with a bonus or tax refund, put your plan in writing – this can make you more likely to stick with your budget.
Once you’ve paid off the debt, you might even consider starting a special savings account so that hopefully you won’t find yourself in the same situation when the holidays roll around next year. Paying 16% APR on your holiday purchases — the average interest rate charged on a general use credit card — is not the best money management decision.
Avoid Retail Store Credit Cards – They’re Even Worse
As a final word of advice, you should know that it can be a very bad idea for your credit to use new retail store credit cards to finance holiday purchases.
Just like traditional credit cards, large balances on retail store cards can lower your credit score. However, since retail store cards are notorious for their low credit limits (coupled with generally high interest rates), even a relatively low balance on a retail store card could max out or nearly max out your available credit limit.
When you combine the probability of a maxed-out card with a new credit inquiry (prompted by opening the account) and throw in a high interest rate to boot, a retail store card could be a trifecta of trouble for your credit in the new year.
- Four Ways Holiday Shopping Can Crush Your Credit
- This One Factor Affects Your Credit Score More Than Anything Else
- How to Handle Post-Holiday Debt
John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. He has written four books on the topic and has been interviewed and quoted thousands of times over the past 10 years. With time spent at Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.
The post There’s a Right Way and a Wrong Way to Take on Holiday Debt appeared first on The Simple Dollar.