Welcome to the final post in our series: How Understand Credit Helps Raise Your Score. Today I’m going to discuss how to get your debts under control. Doing so will improve your credit score and increase your eligibility to be pre-approved for a home loan!
It’s all too easy for it to happen… even if you have the best intentions and a history of always paying your credit cards in full, maybe your balances have gotten out of control and you are among the millions of Americans carrying thousands of dollars in credit card debt.
Part of what it takes to qualify for a home loan, whether it is FHA, VA, USDA (zero down), or Conventional, is for your debt-to-income ratio to be within an acceptable range. In other words, how much money do you owe to creditors compared to how much money you earn? If the percentage of your income that is being spent on other debt is too high, there is the possibility that you won’t be able to buy a house. If you already own a home you may not be able to refinance it.
Ideally, you should have no more than 3 – 5 credit cards. Any more than that opens the door for your finances to get overextended and for payments to be overlooked. If you have more than that, it may be a good idea to get rid of them. People often tell me they’ve been advised not to close credit cards because they’ve been told it can hurt their credit score. While that is true to some extent, it does not mean you can never close a credit card – it just means you have to do it the right way. Too much activity of any sort on your credit report can drive down your credit score, including opening or closing credit cards and having multiple inquiries made into your credit.
If you have too many credit cards with balances on them, how do you get it under control?
I often see people who pay just a little more than the minimum amount due on every credit card in the futile hope that this will pay them off faster. If you are doing this, you may have noticed that you aren’t really getting ahead on any of the credit cards.
What may work better is to choose one card (typically the one with the lowest balance) take all that extra money you’ve been applying to the other cards, and pay it towards just one credit card.
For example, you have:
Card #1 with a $5,000 balance and a minimum payment of $250, so you send in $275;
Card #2 with a $1,000 balance and a minimum payment of $125 so you send in $135;
Card #3 with a balance of $500 and a minimum payment of $30 so you send in $35;
Card #4 with a balance of $250 and a minimum payment of $20 so you send in $25.
Hold it right there. Stop.
Instead of doing that, if you made the minimum payments on everything except Card $4 with the $250 balance, and applied all of the extra money towards that ONE card, then you would be applying $65 per month towards it and it would be paid off in 4 months! The trick then is to go to Card #3 (the one with the $500 balance) and make the minimum payment of $30 plus the $65 you’ve been paying towards the one you just paid off. That card would be gone in 5 or 6 payments.
You get the picture.
This works better than any other method I’ve found of paying off credit card debt.
The next step is to get rid of some of them.
The tricky part is how to figure out which ones to close. What works best is to keep the credit cards open that have the highest limits and that you’ve owned for the longest period of time. If your credit report shows that you’ve had a long and successful relationship with your creditors, that is good for your credit score. And leaving cards with high limits open is good because the more available credit you have the better it is for your credit score IF you make sure you are using no more than 30% – 50% of the limit.
If you carry a balance that is close to the available limit, that will hurt your credit score also. When you decide to start closing credit cards, close only one at a time and wait 30 days between closing them.
To protect yourself against identity theft, be very insistent that the creditor sends you confirmation that the card is closed. If you close a credit card and they have not sent you confirmation in writing within 30 days, call them and ask them to. Repeat this every 30 days until they send you something, then keep the proof it has been closed with your important documents.
But First, Get Pre-Approved 