Cost of living and your credit

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Cost of living and your credit

Cost of living and your creditYou know that where you live matters when it comes to your disposable income. Cost of living makes a big difference in your budget. But can it also impact your credit? You might be surprised at how your cost of living might also matter when it comes to your credit. When you have a high cost of living, your income might not keep up with your expenses, and for many people that means debt. If your debt becomes unmanageable, that can, in turn, affect your credit.

Borrowing to make ends meet

Do you live an area that requires you to borrow to make ends meet? If you are borrowing to make ends meet, that can eventually affect your credit. “It’s going to depend on the cost structure of things, in terms of where you live, and your wants and desires,” says Michael Chadwick, CFP and CEO of Chadwick Financial Advisors.

“If you live in a high rent district, it’s going to be far more difficult to buy a home or keep up with the Joneses if you’re on a fixed income,” Chadwick points out. In some places, like San Francisco and New York City, it’s easy to spend a large portion of your income just on day-to-day living expenses like housing costs, utilities, and transportation. 

In some cases, regular living expenses can be high enough that borrowing is part of how consumers make ends meet. You might think that you are just borrowing a little bit for now, but the reality is that if you can’t make ends meet this month, it’s going to be even harder next month when you have a debt payment as well as your regular expenses. Pretty soon, you find that you are just paying the minimum payments on your credit cards since it’s more affordable than paying off the balance — or even half the balance.

Over time, your balances rise. This impacts the credit utilization portion of your credit score, bringing your score lower. At some point, though, your balances and your minimum payments will reach a point at which you can no longer make the payments with ease, and you might start paying late, or even missing payments altogether. Since payment history is the biggest factor in determining your credit score, once you get to the point where you can no longer afford your debt payments on top of your living expenses, the damage to your score can be surprisingly swift.

Living in an area with a high cost of living means that you might have to compromise, looking for ways to reduce your expenses so that you don’t exceed your income. “If you live where things are cheap, you may not have to compromise,” says Chadwick. Where you live changes the way you approach your finances, he points out. Your situation changes “either how you compromise on your wants and desires or your credit score. You choose how it’s going to go.”

Applying for credit

The process of applying for credit is the same, no matter where you live. However, the cost of living in your area can impact the type of loans you qualify for, and the rates you receive. If your income doesn’t quite provide you with enough leeway when it comes to your cost of living, some lenders might disqualify you based on your income. You might be forced to apply for credit at lenders willing to take on more risk, but you will need to pay a higher interest rate. 

Additionally, if you have been borrowing to make ends meet, and you’ve already racked up debts that are impacting your credit score, it can make it harder to get approved. “Where you live cannot so much change the way you apply for credit,” Chadwick says, “but your need for it may vary if costs are higher.” 

In areas with a high cost of living, you might also have to limit what types of loans you choose to take on. High-cost areas tend to have very expensive homes. Buying might not make sense in these areas due to prohibitive costs. If you can’t truly afford to make home payments, risking your future credit to a foreclosure might not make sense. Since moving from Utah, my husband and I have discovered that it would cost us three to four times as much to buy a home comparable to what we had before. On the other hand, the rent on an apartment with slightly less square footage (250 square feet) than our old home is “only” about twice our mortgage in Utah. Our decision to avoid mortgage debt while we live in a higher cost area will also likely eventually impact our credit, since part of a credit score is based on the types of credit you have — and a mortgage counts for a lot, especially if you pay it on time each month.

You might also decide to avoid buying a car in an area with a high cost of living. I know several consumers living in major metropolitan areas that don’t bother with cars. Car loans are expensive, and cars come with maintenance and repair costs, as well as insurance costs. Taking public transportation costs less than owning a car in many major cities with high living costs. 

Choices you make about what types of credit you apply for can help you avoid getting in over your head with debt and ruining your credit in the long-term.

Manage your cost of living for the benefit of your credit 

“Even if you live in an expensive place, you can find less expensive options or alternatives within that place,” says Chadwick. Some of the suggestions he makes for reducing your cost of living in an expensive area include:

  • Buy a certified used car rather than a new car
  • Buy items off-season
  • Use coupons
  • Shop sales
  • Buy used and at thrift shops
  • Share living quarters when applicable

Managing your cost of living can help you avoid the need for debt to finance your lifestyle. If you can’t or won’t move to an area with a lower cost of living, you’ll have to make adjustments to your spending to avoid getting into a situation where your cost of living destroys your good credit. “Generally speaking, do not finance things for daily living,” suggests Chadwick. “You must plan ahead and be a smart consumer.”