Suze Orman's Action Plan (6 page)

ACTION:
Just paying the minimum sends a huge warning signal to your credit card company. It’s a tip-off that you may already be on shaky ground. To be sure, in flush times, credit card companies didn’t worry about this too much, but when the going gets
tough, credit card companies get scared that you will be unable to repay your debt. As we saw throughout 2009, credit card companies aggressively cut the credit limits or closed down the accounts of customers they deemed the most risky.

If you have an eight-month emergency savings account tucked away, then paying more than the minimum due on your credit card bills is a smart way to try and avoid a credit-limit cut. But if you do not have that emergency savings fund in place, I am not recommending that you push yourself to make higher payments on your credit card debt. You must make it your first priority to build up a savings account. If that means you continue to make only the minimum payments due so you have money to put toward your emergency savings fund, that is the trade-off you may need to make. It is not ideal, but it is realistic. It is a temporary necessity—a provisional game plan until your safety net is securely in place. Yes, paying the minimum amount due may lead to having your credit limit cut. But in 2009 even customers who made bigger payments to get their balances paid down saw their credit limits cut and their accounts closed. That created a bigger problem. If you had used all your cash to pay off the debt and then still had the card limit cut (or the account closed), how were you to cover emergencies? You had no lifelines left.

The reality is that you cannot rely on your credit
card to work as an ad-hoc emergency savings fund. As so many of you learned in 2009, just when you need to use your credit line you may find it sharply reduced or even revoked. So that’s why I say you need to make the best of a bad situation: There can be negative repercussions to continuing to pay just the minimum due on your credit card, but it is still the smarter move so you will have more money available to build up an emergency savings account. (Later in this chapter I explain a strategy that, if feasible for you, can enable you to simultaneously build savings and pay down your card debt.)

ACTION:
In the wake of the financial crisis, credit card companies were looking everywhere to reduce their risk. Even customers with FICO credit scores of 800 or better (any score between 720 and 850 is considered the gold standard) saw their credit limits reduced. This had nothing to do with the customer; it was all about credit card companies wanting to reduce the outstanding limits they had on their own balance sheets.

If your monthly credit card bills amount to less than 10% to 20% of your remaining credit limits (on all your cards), you need not worry. Your FICO
credit score will not be hurt. The only potential problem is if a credit-limit cut causes your debt-to-credit limit (explained in full later in this section) to rise above 25%. That can indeed cause a big hit—50 points or more—to a high FICO score. You might consider opening one new account to add more available credit and help keep your overall debt-to-credit ratio low. Opening a new credit card might cause a slight dip in your credit score over the short term, but it buys you long-term insurance to protect yourself from a bigger score reduction if your credit limit is cut and sends your debt-to-credit ratio soaring. And I know I can trust you to use that card responsibly, right? After all, you just told me you have a sparkling FICO score.

ACTION:
I realize this is a bitter pill if you are already financially stressed, but being forced to pay a higher minimum is actually good medicine for your long-term financial health. The more you send in each month, the faster your balance will be paid off. Now, that said, the timing of this change is ridiculous. It makes me so angry that the same people who seduced consumers into
super-low minimum payments during the good times (the lower your payment, the more the card company earned in interest on the unpaid balance) are now applying the screws when so many families are already stretched so thin. Some card issuers have raised the minimum due each month from 2% of the balance to 5%.

If you can afford the higher payments, grit your teeth and pay them. As I said, the more you pay now, the better. If that’s not feasible, read my advice later in this chapter on transferring your balance to a credit union credit card. Credit unions typically charge much lower interest rates on credit card balances. And be sure to check out my advice in “Action Plan: Spending” on ways to find more money in your budget to put toward financial goals, such as paying off your credit card balance. If you absolutely know you can’t afford the higher payment, call up the credit card issuer and see if you can negotiate a workout. The card company may be willing to convert your credit card balance to a fixed-interest-rate loan that you repay over a set period of, say, two to five years. But there’s a trade-off: The card will be canceled, and that can end up hurting your FICO score. But that’s a price you may need to pay to deal with this situation. The bottom line is that the sooner you get out from under the credit card company’s claws, the better off you will be financially.

ACTION:
Once again, I need to be clear here: Credit card companies can cut limits any time they want and for any reason. And to be honest, if they see you aren’t using your card, that’s an easy call for them. But as I explained above, when credit limits are cut it can have a negative impact on your FICO credit score. If you have already been hit with a credit limit cut, consider opening one new card so you have a new credit limit to add to your account. Obviously, I want you to do this only if you are a stellar manager of credit cards; this advice is for those of you who have FICO scores of 720 plus and aren’t a risk to mismanage new credit. Once you get the new card, use it at least once a month to keep it active.

If you are someone who has an emergency card tucked away unused, I want you to dust it off and put it to use every month. An active card can be less likely to be hit with a credit-limit reduction. This is not an excuse to spend more. I simply want you to shift one of your existing expenses to this card. You don’t even need to carry it in your wallet; move one of your recurring monthly payments onto this card and you’re set. Just remember to pay the bill on time.

ACTION:
Pay off your balance every month and your FICO credit score will not be affected. Your FICO credit score is based on a series of calculations that measure how good a credit risk you are. One of the biggest factors in your credit score—accounting for about 30% of your score—is how much debt you have. There are a few ways that this specific calculation is done, but one of the chief ways it’s determined is the debt-to-available-credit ratio. Debt is how much money you owe on all your credit cards. Available credit is the sum of all the credit lines that have been extended to you. The higher your debt, the worse it is for your FICO score. And your debt-to-credit ratio will look much worse if your credit limit is cut.

Let’s say you have only one credit card that has a $2,000 balance on it. Last year your credit limit on that card was $10,000. So your debt-to-credit ratio was 20% ($2,000 is 20% of $10,000). Now you find out that your credit card company has reduced your credit line to $5,000. That means your ratio shoots up to 40% ($2,000 is 40% of $5,000). That will indeed have a negative impact on your FICO score.

The only way to keep your FICO score unaffected by a credit-limit reduction is to get out of credit card debt and pay off your bills in full each
month. But if you don’t yet have an eight-month emergency savings fund, you need to be strategic on what task to focus on. Later in this chapter I explain how to handle credit card debt if you have yet to build an eight-month emergency savings fund.

ACTION:
Even if you pay your bill in full each month, you likely will have a debt-to-credit ratio that is above zero. You need to understand that your credit score is calculated by taking a quick snapshot of your finances right when the score request is made—by you, or by a lender. If the request comes a week before you have paid your credit card bill, it may show the current unpaid balance. For example, let’s say you have a $10,000 credit limit and this month you have $3,000 in new charges that you intend to pay in full well before the bill is due. If your score “snapshot” is taken before you have paid the bill—even if you pay on time—your debt-to-credit limit will nonetheless show up as 30%, and that can affect your FICO score. One way around this is to boost your total credit limit by getting a new card, but only if
you promise you will not increase your spending (just shift some charges to your new card).

I also advise anyone who is about to apply for a mortgage or a car loan to try to limit their credit card purchases. Not using the credit card at all for two months before you apply for a loan is ideal; that’s the only way to ensure that when your credit score is “pulled” by a lender your debt-to-credit ratio will be zero.

ACTION:
Of course you do! When your account is canceled, it is because the credit card company has labeled you a high-risk cardholder. What is being canceled is your ability to use that card in the future. But you are still responsible for every penny of your existing balance.

ACTION:
Focus on getting the balance paid off; the lower the balance, the less it will damage your FICO score if your card is canceled.

There are two issues that come up when a card is canceled: how it affects your debt-to-credit-limit ratio and what happens to the interest rate on your
unpaid balance. In many cases, when a card that has a balance on it has been revoked or canceled, the credit card company will immediately raise your interest rate to about 30%. When this happens, if you continue to pay only the minimum monthly payment, you may never get out of debt on that card.

ACTION:
There is no such thing as a permanent fixed interest rate on your credit card. The rate is fixed only until the credit card issuer decides it isn’t. It’s a marketing ploy. And credit card companies have all sorts of reasons (embedded in the agreement you accepted when you opened the card) to raise your rate.

But Congress pushed through changes—finally!—that regulate how card companies can manipulate your rates. Beginning in February 2010, as long as you make timely payments on an existing balance—even just the minimum—your interest rate cannot be increased on that balance. If you fall more than 60 days behind on your payments, the card company has the right to raise your interest rate. But if you then get back on track and make six months of on-time payments, your rate must then revert to the lower rate. That is, six months of good behavior means the penalty rate expires.

Another new regulation beginning in February 2010 stipulates that as long as you are on time with your payments, the credit card company can raise your interest rate on only new charges, and even then it must give you 45 days’ advance notice of its new policy.

If you want to steer clear of being hit with a giant rate hike, don’t run up a balance in the first place. Or if you do have an unpaid balance, make sure you make timely minimum payments at the very least. Beginning in February 2010, you will find some measure of protection from any future hikes on that existing balance if you can observe these rules. But let me be clear, the absolute best action is to get your balance paid off in full, pronto. When you have a zero balance, what do you care about the interest rate?

ACTION:
Build a real emergency savings account. Relying on your credit card to bail you out of emergencies is too dangerous. (See “Action Plan: Saving” for advice on where to open a savings account and “Action Plan: Spending” for action steps on how to come up with more money to put toward a savings fund.)

If you use a credit card for an emergency expense and you can’t pay off the balance, you will set off a vicious cycle. An unpaid balance where there once was none makes a credit card company nervous. It can also make other credit card companies you have accounts with nervous. That could cause the credit limits on all your cards to be cut. And if that causes your FICO credit score to drop, then you can expect the interest rate on your credit card to rise.