Once upon a time, there was only one alternative to spending with credit cards: cold hard cash. But then came debit cards—accepted everywhere just like credit cards, but without annual fees, finance charges, and the looming risk of lifelong indebtedness.

Today, credit card alternatives are growing steadily and are looking even more attractive. That said, some alternatives to mainstream, unsecured credit cards are total rip offs—like many prepaid debit cards and even many secured credit cards.

Good Credit Card Alternatives

There’s nothing wrong with cash and traditional debit cards, but a couple of new products provide some credit card perks (cash rewards or the ability to borrow for a big purchase) without credit card trickery (minimum payments and creeping interest rates).

Rewards Debit Cards

Debit cards are becoming Americans’ plastic of choice. In 2009, debit card transactions surpassed credit card purchases for the first time in history thanks, in part, to debit cards’ popularity among younger spenders.

That’s great, because it shows that more Americans are becoming debt-averse. As I’ve written before, however, some debit cards have a ways to go to match benefits credit cards offer like cash rewards and fraud protection.

But now, there are rewards debit cards.

PerkStreet Financial offers a debit card tied to a free checking account that pays users one percent cash back on all non-pin purchases. So you can get cash back for your spending without giving business to a credit card company!

Peer-to-Peer Lending

I am a huge fan of peer-to-peer lending sites like Prosper and Lending Club; they let individual investors make loans directly to borrowers. With no bank in the middle, investors get higher returns and borrowers enjoy lower rates on personal loans.

Case-in-point, three years ago I took out a Prosper loan to consolidate debts at a savings of about four percent. Now that my loan is paid off, I’m starting to lend money and an earn eight or nine percent annual return; far better than the paltry one or two percent banks are paying these days.

Although I don’t advocate going into debt, if you absolutely need to borrow money for a big expense, consider getting a 36-month peer-to-peer loan at a fixed interest rate instead of borrowing on credit cards.

Learn more about:

• Prosper Loans
• Lending Club

Not so Good Credit Card Alternatives

I dig rewards debit cards like PerkStreet and the peer-to-peer lending model. But if I were you, I’d stay away from these products that disguise themselves as alternatives to credit cards but will actually end up costing.

Prepaid Cards

Prepaid cards, sometimes called prepaid or re-loadable debit cards, seem like a good alternative to credit cards: You transfer money onto a the card and use it like a debit card; you can only spend what you have. Problem is, these cards are re-loadable cards are loaded with fees.

Each card has a different fee structure, but these are some of the fees I’ve seen on prepaid cards:

• Account opening fee
• Per transaction fee ($1 or $2 every time you use the card)
• Re-load fee
• Monthly fee
• Inactivity fee
• Customer service fee (every time you call them)

Although these cards are often marketed to individuals without bank accounts, I have seen some marketed to college students and otherwise savvy but credit-averse folks.

If you know of a fair prepaid card, let me know in a comment. Otherwise, do your homework before you sign up for one of these cards!

Secured Credit Cards

Although secured credit cards are, in fact, credit cards; I consider them an alternative to regular, unsecured credit cards because you can’t exactly go into debt with a secured credit card.

On the surface, secured credit cards look like prepaid cards. You deposit money into a savings account and that deposit becomes your credit limit. You can make charges on the secured credit card up to your credit limit, and you pay back the charges monthly (either in-full or over time).

The big difference is that secured credit cards report your payment history to the credit bureaus, so you’re building credit history. You can’t go into debt, because you haven’t actually spend money you don’t have. For these reasons, secured credit cards can be a good tool for anybody having trouble building or reestablishing credit. Just be careful, as the majority of secured credit cards are marketed to people with major credit problems and, as such, contain outrageous fees up to several hundred dollars a year.

You’re much better off calling your existing bank and asking if they offer a secured credit card product. Expect to pay an annual fee for a secured credit card, but if you’re looking at a fee over $100, you’re probably being taken.

What do you think? Do you use a credit card alternative that I didn’t mention here? Let me know in a comment!

Related posts:

1. When To Consider a Secured Credit Card
2. Two Alternatives to High Yield Savings Accounts
3. American Express Will Pay $300 for Closing Your Credit Card Account

That’s because the CARD Act takes effect this winter and will restrict credit card companies’ ability to raise interest rates on existing customers. If you thought credit card companies were committing usury in the past with APRs of eighteen, or twenty percent; you ain’t seen nothing yet. Cardholders are seeing their rates go as high as 29.9 percent; there’s even a story of man who received a credit card offer at 79.9 percent APR!

How do you know if your card is raising your interest rate? What can you do about it?

How Credit Cards Raise APRs

In general, your credit card company must notify you of any changes to your account, including interest rate increases, by mail (or electronically if you have consented to receive legal disclosures online). Unless you pay late. Most cards’ terms and conditions include a clause that allows them to raise your interest rate if you pay late or go over your credit limit; no notification required.

Manage your cards well? You’re not immune to rate hikes.

My wife just received a notification from Citi that her interest rate will jump to 23.9 percent in December. That’s on a card with a $15,000 credit limit that does not have a balance and has always been paid in full. (We use the card for joint expenses each month and pay it in full).

She received a letter yesterday detailing the change. Unlike other rate increases I have seen, however, this notice had an interesting clause. If my wife were to transfer a balance of $3,000 or more to the card (plus a fee), Citi would actually lower her rate to 9.9 percent on the balance transfer and all future purchases until 2011. Obviously, Citi is just trying to make some money off this account. Since we always pay the balance in full and the card has no annual fee, they never get a dime from us in interest.

Just be sure to watch the mail.

A lot of these credit card rate increase notices look like junk mail. But if you miss them, you may miss your opportunity to opt-out of the rate increases.

How to Opt-Out of Rate Increases

When your credit card company raises your interest rate arbitrarily (i.e., not because you paid late), they must give you the opportunity to opt-out. Usually, you must contact the card’s customer service to opt-out. If you opt-out:

• You can pay off the existing card balance at your current (lower) interest rate.
• When the debt is paid off, or when the card expires, the credit card will be closed.

If you don’t opt-out by the specified deadline, your rate will go up and you won’t be able to do anything about it after the fact. So if you’re carrying a balance and your credit card company notifies you of an extreme rate increase, you should probably opt-out (unless you can pay off the balance in-full immediately). This is the time to forget about whatever effect closing your credit card has on your credit and just get far, far away from this nasty interest rate.

What to Do Next

If you’re not carrying a balance on the card that raised your interest rate, there’s little point to opting-out. As long as you don’t take on debt on that card, who cares about the APR? You might, however, be so outraged with the card company that you want to stop doing business with them. Or, you might want to preserve a lower APR “just in case” you need to revolve a balance on the card in the future.

Try negotiating.

In the past, customers with excellent payment histories could often be successful just calling up their credit card company and saying “Hey, I can get a 13 percent APR with Card ABC or Card XYZ, why should I stay with your card at 20 percent? What can you do for me?”

This strategy is certainly still worth a shot, although you can expect to have a harder time getting concessions from card companies. For one, they know that it’s harder for customers to switch to a new card (due to tightened credit requirements). Second, the card companies need the money. (Not that I expect you to have a lot of sympathy). But with sky-high default rates and the new laws limiting sneaky fees and interest rates that used to make credit card companies lots of cash, they’re trying to figure out how to make money on a totally new playing field. For now, that means charging even their best customers ridiculous interest rates.

Or, get a new card.

If you have really good credit and little or no credit card debt, you’re in luck, because you can probably apply and get approved for a new credit card at a much lower APR than on existing cards you have. (Most cards are offering new customers APRs ranging from 12 to 18 percent; not great, but better than 24 or 29 percent). Your best bet is to apply with companies that are actively seeking new creditworthy applicants, like Chase and Discover. Chase’s Freedom card has been a perennial favorite of card-critics for its simple rewards program, and the new Chase Slate card provides a lower rate, albeit no rewards, for customers who want the flexibility of paying some purchases over time.

• Compare and apply: See my list of recommended credit cards.

What about you? Have your credit card interest rates gone up? How high? What have you done about it? Please share your story in a comment.

Related posts:

1. Beware Credit Card Rate Jackings (Increases)
2. Summary of the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009
3. For the Lowest Credit Card Interest Rates, Look to Small Banks

But as one person already commented—banks will cancel your credit cards if you don’t use them. Because you want to keep at least two credit cards open to continue building credit, you want to make sure the two cards you keep stay open. So you should use them from time to time.

Re-Think Your Credit Cards! from David Weliver on Vimeo.

What Credit Cards Do Best

The real argument for spending with a credit card instead of a debit card or cash is not the rewards you’ll earn. As I mentioned yesterday, credit cards play with your psychology and actually make you spend more than you would with cash. The real benefits credit cards offer that you can’t get from other payment methods are:

• Fraud protection
• Leverage in disputes with merchants
• Travel insurance and convenience

Credit cards are better for fraud protection because if they’re stolen, the most you’ll be liable for is $50. Plus, if somebody makes fraudulent charges, it’s not your money they’re stealing; it’s the bank’s. Also, if you make a purchase with a credit card and the merchant ends up charging you too much or doesn’t fulfill its obligations, the credit card company can help you dispute that charge. In many cases, you won’t have to pay the charge until the issue is resolved. If you had paid cash and gotten ripped off, your money is already long gone.

Also, most credit cards provide some minimal travel insurance programs. If you book air travel with a credit card and the airline damages your baggage, your credit card may cover some of the loss. Ditto for car rentals. Rent a car with a credit card, and the card provides some level of additional insurance if you bang up the rental.

Last but not least, credit cards are far more convenient than debit cards or cash when you travel. Hotels and car rental agencies need deposits—sometimes several hundred dollars. With cash or a debit card, you actually need to give them this money up front. With a credit card, they just put a hold on a portion of your credit line; you never have to part with any of your money for the deposit.

How To Use Your Two Credit Cards

With some of these benefits in mind, here’s how to best use the two credit cards you keep open. Use the card with the higher credit limit for:

• Big purchases, say over $100
• When you travel

You’ll protect yourself when you make big purchases and it’ll be far more convenient to travel. You may not use the card every month, but you should use it enough that the bank won’t cancel your card. Of course, pay the card in full every month.

Use the second credit card for a few fixed monthly expenses. I recommend setting up your card to automatically pay a few monthly bills, such as:

• Your gym membership
• Your cell phone bill
• Your car insurance

You’ll pay one bill every month instead of three, and you’ll be keeping that card open and building credit at the same time.

Re-Cap

So between yesterday’s post and today, I’ve laid out my new strategy for using credit cards minimally and wisely. The strategy is this:

• Cancel all but your oldest credit card and the card with the highest credit limit
• Use one card for big purchases and travel
• Use the second card for a few recurring monthly bills

What do you think? Good idea? Do you want to scream at me for suggesting people still use credit cards at all? Think I’m stupid for not recommending people take more advantage of rewards? Let’s hear it!

For a case study of this strategy, please see “I have seven credit cards. Should I cancel any of them?“

Related posts:

1. Radically Re-Thinking Credit Cards: Part One
2. Charge Cards: American Express Offers an Attractive Alternative to Credit Cards
3. The Better Deal: Cash Back or Miles Credit Cards?

• Credit cards are evil and you should cancel them and never, ever use them again.
• Credit cards are fantastically convenient when used responsibly and can actually make you hundreds a year in rewards.

Both are wrong.

Been burned by credit cards? It’s tempting to do what Matt did: Close ‘em, shred ‘em, and forget ‘em. If you’re either so mad at the card racket or think you can’t trust yourself with credit, then cancel ‘em. But before you do, consider this: Canceling credit cards makes it harder to maintain good credit. Hope to apply for a mortgage? (Or even an apartment?) You’ll want good credit.

Some money wizards recommend shredding your cards; others say “credit cards are greeeat!” After all, card rewards earn you a couple hundred extra bucks a year. Unfortunately, most rewards-seeking spenders will actually spend more money than they’ll earn in rewards using a rewards credit card. Let’s take a closer look at both of these fallacies.

Re-Think Your Credit Cards! from David Weliver on Vimeo.

Why You Shouldn’t Cancel All Of Your Credit Cards

Canceling all of your credit cards is tempting, especially if you’re sitting in loads of credit card debt and the cards are already maxed out anyway. Better to just get rid of them so you won’t use them again, right? While you’re digging out of credit card debt, you need to make sure you don’t go into any new debt. Solution? Eliminate your access to your credit cards. In this situation it’s a good idea to:

• Freeze your credit cards or
• Cut them up.
• Just don’t cancel them!

Canceling all of your cards is short-sighted. You do hope to be out of credit card debt eventually, right? And, hopefully, you plan to have learned a lesson and be in a better position to use credit cards responsibly (i.e., pay them in full every month). If that’s the case, you’ll want your credit cards open. But maybe not all of them. That’s why I’m going to recommend this: cancel all your credit cards but two. (After all, you really shouldn’t need more than two cards).

Which cards should you keep open?

• The card with you’ve had the longest.
• The card with the highest credit limit.

Why these two?

If you use credit cards the way I’ll suggest in part two, the interest rate won’t matter because you’ll never carry a balance. As for rewards, keep reading. You don’t need ‘em. Keeping your oldest credit card and the card with the highest limit, however, is best for your credit. Accounts that have been opened longer and accounts with higher credit limits, in general, equal a better credit score.

If you’re in so much debt your credit cards are maxed out, your credit score isn’t very good because your utilization ratio (how much debt you have versus your total available credit) is really high. But as you pay down your debt, your credit recovers. Canceling all of your credit cards will actually hurt your credit score even further, because you no longer have available credit and your utilization ratio will be over 100 percent until you’re totally out of debt. Once you’re debt-free, getting a new credit card may still be difficult for months or years to come. By canceling all but two of your cards, you’ll still have cards open available when you’re out of debt.

Let me add a disclaimer: If you know you can’t trust yourself with credit cards, then ignore this advice and do cancel your credit cards. Never use them again. But if you would like to learn to use these tools to your advantage—responsibly—keep reading.

So, why don’t I recommend you keep the card with the best rewards?

Why You Shouldn’t Chase Credit Card Rewards

Credit cards make you spend more. In The Illusion of Credit Card Rewards, Tough Money Love discusses this phenomenon, citing psychologists who found:

[Two studies] demonstrated that people are willing to spend (or pay) more when they use a credit card than when using cash. Importantly, the results of both studies suggest that the underlying reason for the differences in spending is, at least, partly due to differences in the pain of paying.

Note that these studies aren’t even looking at the rewards cards—just credit cards in general. When you add rewards into the mix, you actually have an additional incentive to spend more than you might ordinarily—you’re getting airline miles or cash back! Yippee! The bottom line? Credit cards are engineered to get you to spend too much. Even if you can pay the card every month, you still spend more than you would otherwise.

You can think that you’re smarter than everybody else and can still beat the system, but you’re only fooling yourself.

My conclusion is that it’s silly to chase credit card rewards. If your card offers them, great. You’ll earn some when you use the cards as I describe in Part Two. But never try to cram all of your monthly spending onto credit cards just because of the rewards. It’s a recipe for overspending.

For a case study of this strategy, please see “I have seven credit cards. Should I cancel any of them?”

Part Two: A New Way to Use Credit Cards

In Part Two of Radically Re-Thinking Credit Cards, I offer a new strategy for using the two credit cards you do keep minimally and responsibly (so the banks won’t cancel them). Read part two now »

Related posts:

1. Radically Re-Thinking Credit Cards: Part Two
2. Charge Cards: American Express Offers an Attractive Alternative to Credit Cards
3. The Better Deal: Cash Back or Miles Credit Cards?

Note: Next week, the National Foundation for Credit Counseling and the Council of Better Business Bureaus will promote “National Protect Your Identity Week”. This article kicks off a four-part series on Money Under 30 featuring simple steps you can take to protect your most precious virtual asset—your identity!

• Today: Seven Signs You’re At-Risk for Identity Theft
• Wednesday: Beware Credit Card Skimmers and How to Spot Them
• Thursday: Beware Phishing Attempts and How to Spot Them
• Friday: Everything You Need to Know About Protecting Your Identity

The Seven Signs

1. I use an easy-to-remember password or the same username and password for multiple Websites.

Identity thieves can capture your information in myriad ways. Increasingly, thieves steal your ID online via malware they secretly install on your computer. That’s why it’s critical to use passwords that are hard to guess (especially for any financial Websites) and to never use the same password for more than one critical account. Never use your address, birthday, relative’s names, or any other easy-to-guess password. If you’re using the same password or easy-to-remember passwords, change them today!

2. I have sent e-mails containing financial information or one of my usernames or passwords.

E-mail is not secure. It’s safe to assume that somebody else could read anything you send over e-mail (on a personal or work account). Hackers can break into e-mail accounts and even intercept e-mails in transmission. That’s why you should never e-mail financial passwords or other details (even to yourself). There is precious little privacy with e-mail.

3. It’s been more than three months since I checked my own credit reports.

Sophisticated identity thieves don’t just steal credit card numbers and make purchases; they actually open up new loans using stolen credit profiles. If this happens, thieves can rack up tens of thousands of dollars of charges in your name. (And guess what: They’re not going to pay them back!) The only way to detect and stop this kind of identity theft is to monitor your own credit report regularly. You can either pay for an identity theft protection service to do this or you can check your credit for free every few months.

4. I carry my social security number in my wallet.

Your social security number is the “gateway” to your identity and your credit. Without it, thieves will have a hard time establishing credit in your name. If they get it, however, you just wrote them a blank check. Never carry your social security card in your wallet, and make sure other cards you carry (like a student ID, driver’s license, or health insurance card) do not contain your social security number. Only give this number out when absolutely necessary.

5. If my bank called or e-mailed me, I would feel comfortable sharing information with them about my accounts.

Your banks will never ask for identifying information like your password or account number when they call or e-mail you. Never. They already have this information. They may ask for other information like your name, but if somebody is asking for account numbers or passwords via e-mail or phone, it’s not your bank. Identity thieves are pretty clever, and can create e-mails and 800 numbers that may appear to be your bank. Never ever give out this information to somebody who calls or e-mails.

6. I pay my credit cards automatically and rarely review my monthly statements.

Paperless statements and online bill-pay makes it possible to almost forget about our monthly bills. Just because you don’t get credit card statements in the mail, however, does not mean you shouldn’t check them! Always review your credit card statements every month and be on the lookout for charges you don’t think you made. Report them to your card company immediately.

Check your bank account details at least once a week. Although you have 60 days to report fraudulent credit card transactions to avoid liability, you may only have seven days to report fraudulent debit card transactions. If you don’t, you may end up losing any money the thieves took.

7. I keep my checkbook, bank statements, or debit card PIN somewhere others could find them.

Last but not least, do not keep sensitive documents in accessible locations. If possible, destroy any written documentation of your debit card PIN (that’s one to commit to memory). Secondly, guard your checkbooks! Each check contains your bank account and routing numbers—all an identity thief needs to set up an electronic transfer of funds out of your account and into his.

For more on protecting yourself from identity theft, check out ProtectYourIDNow.org, a non-profit Website featuring lots of useful resources. And, don’t forget to check back later this week for parts 2-4 of this series on protecting yourself from identity theft.

Related posts:

1. Identity Theft: What You Need to Know to Protect Yourself
2. Identity Theft Growing in Recession: Protect Yourself
3. Beware Phishing Attempts and How to Avoid Them

1. Be Patient

This one’s so easy, you don’t actually have to do anything! The older your credit file, the more stable it will be. If you have a proven, positive credit history, lenders will feel more comfortable extending credit to you. Your credit report is an ever-changing file: every time you use credit or make a payment, your credit profile and your score change. That means that any flaws you have in your credit history will disappear over time. Focus on handling your credit accounts in a positive manner and your credit report and score will improve.

2. Don’t Close Old Accounts

Even if you haven’t used an account for a long time, leave it alone; it will only help your credit score. The longer your positive track record and the lower your overall utilization rate (or the amount of credit you’re using compared to the amount of credit that’s been extended to you), the higher your credit score will be.

3. Keep Your Debt Load as Low as Possible

Pay your debts down! People with a lot of debt pose a greater risk than those with less debt. Maxed out credit cards mean a higher utilization rate, and a lower credit score. Keep your utilization rate low by paying down credit cards or negotiating higher credit card limits.

4. Don’t Apply for Multiple Credit Cards in a Short Time

Every time you apply for credit, the lender “inquires” about your credit history to one or more of the major credit bureaus (Equifax, Experian, and TransUnion). Too many inquiries in a short time span can lower your credit score, so only apply for credit or a loan if you really need it (not just because you get a free baseball cap or 10% off your retail purchase if you apply).

5. Use The Right Kind of Credit

Avoid finance companies, which are often the lenders behind retail credit card accounts and payday loans. They not only charge a much higher interest rate, but just doing business with “high risk” lenders like these can actually lower your credit score. Stick with major credit cards and bank loans. Also, make sure you’re getting credit for your great credit. Believe it or not, some lenders don’t report your account to the credit bureaus, so be sure to ask that they do.

6. Separate Accounts After Divorce of Death of a Spouse

Don’t let your ex-spouse’s terrible credit drag you down. If you were relieved of debt obligations in the divorce decree, make sure to follow up with all three major credit bureaus. Additionally, upon the death of a spouse, remove any of his or her debts for which you are not responsible from your credit report.

7. Correct Mistakes On Your Credit Report

It is so important to check your credit report from each of the three bureaus. You may find inconsistent or inaccurate information on one, two, or all three reports. Usually, the error will not be in your favor. Correct any mistakes and your credit score will improve.

8. Pay Your Bills On Time

This is the single most important thing you can do to build and maintain an outstanding credit score. Even if you can’t pay the entire minimum, send something. Then, follow up with a phone call to the lender to explain the situation. This demonstrates good faith to your creditors. If you absolutely can’t make a payment, call the creditor anyway. They are usually willing to work with you (and may even delay reporting the delinquency to the credit bureaus).

Simply follow these eight simple guidelines and you’ll be well on your way to credit score nirvana!

Carrie Davis is a personal finance blogger at SpendOnLife.com, a site dedicated to giving readers true and accurate information about credit, debt, and identity theft. She is FCRA-certified and has a passion for educating others on how to achieve financial independence.

Follow Carrie through the SpendOnLife RSS feed or on Twitter @SpendOnLife.

Related posts:

1. Beware Credit Cards That Do Not Report Your Credit Limit to Credit Bureaus
2. More About Closing Credit Card Accounts and Your FICO Score
3. Q&A: How Can I Close Credit Card Accounts Without Hurting My Credit Score?

The CARD Act’s Under-21 Restrictions

The CARD Act stipulates that creditors are prohibited from extending credit to consumers individuals (I hate the word consumer) unless:

• the consumer individual has submitted a written application that meets specified requirements and
• the application is signed by a cosigner, including the parent, legal guardian, spouse, or any other individual who has attained the age of 21 having a means to repay debts incurred by the consumer borrower in connection with the account.

What I Think

When I first heard about the under 21 provision in the CARD Act, I said “that’s a great idea”. That’s because I started getting into hot water with credit cards way before my 21st birthday. But as I’ve had some time to chew on the idea, I’m starting to think it stinks.

First of all, I’m not a big fan of the government telling citizens what we can and can’t do.

Secondly, the provision may actually be discriminatory under the Equal Credit Opportunity Act, which is in place to

“…promote the availability of credit to all creditworthy applicants without regard to race, color, religion, national origin, sex, marital status, or age (provided the applicant has the capacity to contract)”.

(I’ll leave that debate for the lawyers).

Most importantly, I do not believe age is the best predictor of responsibility. Some people can manage credit responsibly, others can’t. Some people are in a position to get credit at 18, 19, or 20. Others are not.

I don’t believe, for example, that a full-time college student with little or no personal income should have several credit cards with $28,000 of available credit (which I had at 19). But how can the government tell a 19-year old who works full-time, has his or her own apartment, and may even be getting married, that he or she can’t get a credit card?

Creditors should make decisions on issuing credit based upon

• a borrower’s prior credit history and
• his or her means to repay the debt.

The first criterion already makes it hard enough for young people to get credit (See: No Credit History? An Uphill Climb to Auto, Home Financing), why not leave it at that? Meanwhile, credit card companies do not even verify applicants’ income. Why not simply require that they do?

I know first hand that credit cards and college is a dangerous situation, but I really hate the idea of taking away other Americans’ ability to make free choices—regardless of age.

If you’re under 21, you still have time to apply for a credit card on your own before the CARD Act goes into affect. If you do, just be honest with yourself about why you’re getting it. If you’re going to use it responsibly to build credit, great. If you have dreams of financing a trip to Cancun and paying it off after you graduate, take the advice of somebody who made that mistake not so long ago: Don’t.

What do you think? Are the restrictions on issuing credit cards to people under 21 a good idea? More importantly, are they fair? Are they legal?

Related posts:

1. Q&A: What kind of credit score do I need to get approved for a balance transfer credit card?
2. Five Reasons to Apply for a Business Credit Card as an Individual Consumer
3. Summary of the Credit Card Accountability, Responsibility and Disclosure (CARD) Act of 2009

There are only so many reasons your mortgage application may be declined. The most common are:

• Your credit score is too low.
• Your monthly debt payments are too high compared to your income.
• You’re applying for “too much house” for your income and assets.

Lenders and brokers want to approve your mortgage (after all, approving mortgages is how they get paid). So if you don’t qualify initially, they should be happy to explain to you why your application was declined. If they don’t offer this information immediately, ask them. Let’s take a closer look at what each reason means and what you can do about it.

Low Credit Score

Because mortgages are secured by property (the house), even people with shaky credit scores sometimes get approved for a mortgage. The lower your credit score, however, the more interest you’ll pay. Therefore, it’s best to get your credit score as high as you can before taking on a home loan. Still, some lenders burned by issuing too many “sub-prime” mortgages have significantly increased the minimum credit requirements needed to qualify for their loans. So it’s possible to be denied a mortgage on the basis of credit score alone.

The primary factors in a low credit score, in order of importance, are:

• Late payments
• Too much debt
• Too little credit history
• Too many inquiries

Late Payments: Paying your bills on time is the single most important thing you can do for your credit score. One 30-day late payment can drop your score by up to 100 points, and it can take one or two years of on-time payments for your score to recover. Miss more than one payment, or fall 60 or 90 days behind, and your score will really plunge. If your mortgage application is turned down for a low credit score due to missed payments, it’s the easiest fix (pay on time going forward). Unfortunately, it’s the fix that will also take the longest. You may just have to wait between 12 and 24 months before applying again.

Too Much Debt: The second most important part of your score is how much debt you have compared to your total credit limits. For example, if you have $5,000 of credit card debt and a total $10,000 credit limit, you’re using 50 percent of your available credit, which may be too high. Try to get this ratio under 20 percent by paying down debt, even if it means taking cash from your savings for a down payment.

Too Little History: The longer your credit file has been open, the higher your score goes. If you’ve only had credit for a year or two, you may need to wait another year or two before getting a mortgage. Similarly, if you only have one or two credit cards on your report, you may need to take out a fixed installment loan (like a car loan or a debt consolidation personal loan), to improve your “credit mix”. Being anti-debt, I hate to recommend taking out credit…but you can always get the loan and pay it off in full within a few months. It will still help your credit. Finally, if you no credit history at all, you have your work cut out for you. Start with a credit card and work on paying on time for one to two years.

Too Many Inquiries: Mortgage lenders don’t want to see that you’ve been trying to apply for any credit you can get in the last few months; it makes them nervous you’ll get a bunch of credit and then fail to make payments. So it’s a good idea to hold off on applying for credit cards or other credit six to 12 months before applying for a mortgage.

If your mortgage application was declined because of a low credit score, spend $15 a month or so for a few months on a credit monitoring service to track your progress. Your lender may even be able to tell you the score you need to qualify, so when you reach it, you know it’s time to reapply for your mortgage.

Debt-to-Income Ratio

Even if you have stellar credit, a mortgage lender may turn you down for having a debt-income-ratio that’s too high. This is similar, but not exactly the same, as your credit utilization ratio that figures into your credit score. Your debt-to-income ratio (DTI) all comes down to how much you spend every month on minimum debt payments and how much you earn.

This is where auto loans, or other loans that have a high fixed monthly payment, can hurt. If you earn $3,000 a month and have a $400 a month car payment and two credit cards with a total minimum payment of $100, your DTI is about 17 percent. That’s not terrible; trouble is mortgage lenders add your future mortgage payment on top of that. If you’re looking at a $1,000-a-month mortgage, your DTI just jumped to 50 percent, which is too high. Most lenders want to see this ratio under 45 percent—for the sake of your own financial security, it’s better to get it even lower. Read more about what percentage of your income you can spend on a mortgage.

“Too Much House”

The last big reason your mortgage application could be declined is that you’re simply trying to finance too much for your income and assets. This can be solved in two very straightforward ways:

• Shop for less expensive homes
• Increase your equity (down payment)

If your lender tells you that you’re simply asking for too much, you can always reduce your asking amount. For some—such as those in pricey real estate markets like Northern California or the Northeast Coordinator—that may not be an option. Fortunately, there’s another solution: save more! I recommend home buyers put at least 20 percent down. It gives you equity in your home right off the bat and helps you avoid private mortgage insurance (PMI), which unnecessarily increases your monthly housing payment.

If your mortgage application has been declined, take heart: you’re not alone, and with some work, you can ready your finances to buy a home. Looking to get pre-approved for the first time or a second time? Get mortgage pre-approval online from several lenders at once.

Related posts:

1. What Percentage of Income Can You Afford for Mortgage Payments?
2. Are You Ready to Buy a Home? An Easy Way to Check
3. His Credit’s Good, Hers is Bad: Can You Get a Mortgage Anyway?

“I feel, well, shafted,” Matt says. “I thought I did everything right, avoided credit cards, saved and saved, and to [mortgage lenders], it doesn’t mean anything.”

Matt isn’t alone, and even consumers with some credit history (but not enough) are being turned down for much smaller lines of credit than a mortgage.

Kelly, 28, has a simple philosophy about money: “I pay cash for everything. My line of thinking is, if you can’t afford it, don’t buy it.” Even so, Kelly has carried one credit card since she was 18 and, at 26, financed a car specifically to continue building credit. You can imagine her surprise, then, when she decided to take advantage of same-as-cash financing for a $2,000 computer and the store declined her credit application for insufficient credit history.

“I wanted to show the sales associate my bank statement. I have cash. I have savings. I even have a beefy 401K and 403b!”

For consumers without a credit history, and even those with a limited credit history, getting new credit is hard to do.

“There is a small but vocal minority that has never used credit,” says Ken Lin, CEO of credit tracking Website CreditKarma.com in San Francisco. Although Lin understands some consumers’ decision to totally abstain from credit card debt, he says that when used properly “credit is a fantastic convenience”.

And for most consumers who want to buy a home or finance a car before they start going gray, a solid credit history is a necessity. And especially for those needing to start a credit history from zero, getting that first lender to take a chance on you has gotten even harder since last year’s crackdown on underwriting standards.

Ryan, a 29-year old sailor in the merchant marine was in a similar situation to Matt. Several months ago, with $20,000 in the bank but no credit, Ryan couldn’t get approved for a Bank of America secured credit card or even a piece of furniture. He wrote:

“Ever since high school I’ve known that the entire credit industry is a scam, that interest rates and fees are a shell game, and that once you fall just a little bit behind, it can be impossible to catch up…I’ve always been perfectly happy without a card, and only use my debit card…[but now] I can’t get a [mortgage] because I have no credit score. For the last month, I’ve been running around and racking my brain trying to figure out how to get credit.”

Eventually, BB&T approved Ryan for a credit card that his father co-signed. But it wasn’t easy.

How to Go From No Credit to Mortgage-Worthy

When you’re starting with no credit history, most mainstream credit cards and even in-store financing programs (like the loan Kelly tried to get for the computer) are out of the question. There are a few steps you can take.

Become an authorized user on somebody else’s credit card. Almost all credit cards allow the primary cardholder to add an authorized secondary user to the account. There is no credit check on the authorized user, who gets their own credit card and can make charges on the primary user’s account.

Lin recommends this as a good first step. It won’t build a credit history for the authorized user (since the primary user is responsible for the account), but “it does start a credit file,” Lin says. The only catch? You need somebody who really trusts you—most likely a spouse or parent—since you’ll be able to make charges on their credit card.

Apply for a secured credit card. A secured credit card works somewhat like a pre-paid debit card with a few critical differences. To open a secured credit card, you must make a security deposit that becomes your credit line. Unlike a pre-paid card, however, you must repay the charges you make against your security deposit every month, and those payments (hopefully timely) are reported to credit bureaus so you begin building credit.

Most secured credit cards do not check applicants’ credit history, says Lin, but applicants need to be careful when shopping for a secured card. “The pitfall of secured credit cards is they were built for people with poor credit.” That means many cards charge exorbitant fees for a tiny credit limit.

After a year or so, apply for unsecured credit cards. “The average consumer has seven credit cards in their wallet,” says Lin. “That’s probably overkill, but two or three are smart.” Lin recommends using the cards to buy a tank of gas or two each month. Then, pay the balance off every time. It’s a common myth that you have to carry a balance (and pay interest) to build credit. Not true. As long as you use the accounts and make timely payments (even if they are in-full), you will build credit.

Building credit from scratch takes planning and patience. If, however, you can open a few credit lines and pay them on, you should have the makings of a good credit history in 12-18 months. But even then, you not be able to qualify for the auto loan or mortgage you’re after.

“Theoretically you could have a 700 credit score [after 12-18 months of credit building] but may still get declined or pay a higher rate,” Lin says. That’s because lenders don’t just look at your credit score, but at a variety of factors, including the length and breath of your credit history. Making regular $50 monthly payments on a secured credit card with a $500 credit limit isn’t the same as taking on a $20,000 auto loan or $150,000 mortgage. Still, you’ll be in a much better position to get a loan than when you had no credit file.

What if lenders want to charge you a higher rate because of your limited credit history? It might be worthwhile to keep waiting. An article by TheStreet.com calculated that over a lifetime, somebody with poor credit could pay $1 million more in interest than somebody with good credit!

Related posts:

1. How to Prepare to Buy Your First Home
2. Are Joint Credit Card Accounts a Good Idea?
3. Credit Card Alternatives

Blueprint is comprised of four new features: Full Pay, Split, Track It, and Finish It.

Blueprint’s Full Pay feature lets “customers select the types of purchases they want to pay in full each month, such as groceries, prescriptions and other everyday items. Chase separates out these charges on their statement, so customers know the payment they need to make to ensure that these purchases are not increasing their balance or accumulating interest. As long as customers make their Blueprint payment by their due date, they will not pay interest on those purchases.”

The Split feature allows customers to pay off larger purchases, like a computer or emergency auto repair, over time without falling into the credit card minimum payment trap. With Split, consumers decide how much they want to pay each month or how long they want to take to pay the purchase off. After the consumer chooses the repayment term, Chase sets up a plan and includes that payment amount with each statement. The consumer’s payment progress is displayed separately on each statement until the balance is paid-in-full.

For example, if a consumer charges an $800 computer at 12.9% interest, it would take 124 months of making $16 minimum payments to pay off—at an interest cost of $580.88. If, however, the consumer opts to pay $100 a month using Chase Blueprint’s Split feature, the consumer would pay off the computer in nine months and pay only $41.96 in interest.

Finish It applies to existing card balances and works similarly to Split: Consumers can choose a payment amount or repayment term and make regular monthly payments until the debt is paid off. A final feature, Track It, allows customers to set budgets on their card and track month-to-date and year-to-date spending in different categories in real time.

Chase Blueprint: My Take

With Blueprint, Chase brings some long-overdue transparency to its relationships with credit card customers. In an industry known for dubious practices that confuse credit card users and keep them in debt, Blueprint will educate card users about the realities of using credit (like how much it costs) and help users make more educated credit decisions. Does Blueprint make it “smart” or “okay” to borrow on a credit card? Hardly. The best policy is to pay your card in full every month. And for those determined to get into credit card debt, a Chase Blueprint card might be the credit equivalent of a “light” cigarette; they’ll both still kill you in the end.

But I believe Chase Blueprint will help consumers who choose to finance purchases with a credit card pay their balances off faster and save money in the process. I also like the sound of the Track It budgeting tool. For simplicity, I use one credit card for nearly all of my routine monthly expenses, and the ability to check my card balance and spending against my budget in one place would be great.

Want a card with Chase Blueprint? Apply for a Chase Freedom Card (best for cash rewards) or a Chase Slate Card (lower interest rate for paying over time).

What do you think? Is this a feature you would use? Will it make a difference in how consumers use their credit cards?

Related posts:

1. Five Reasons to Apply for a Business Credit Card as an Individual Consumer
2. My Credit Card Raised My Interest Rate! Here’s What to Do
3. Are Joint Credit Card Accounts a Good Idea?