Suze Orman's Action Plan (8 page)

ACTION:
You must be seriously behind in your payments and have a sizable lump sum of cash at the ready to have any shot at working out a settlement that reduces what you owe.

The only way the credit card company will forgive a portion of your unpaid balance is if you can make a lump-sum payment that covers some of the money you owe. Let’s say you have $20,000 in credit card debt that the credit card company is willing to reduce to $10,000. You need to be able to pay cold cash to cover the remaining $10,000 immediately. This is not about getting your balance lowered and then promising to be a good Boy Scout or Girl Scout who will stick to a monthly repayment plan. To get a settlement requires having enough cash at the ready to pay off the entire remaining (reduced) balance. If you don’t have that money, you aren’t likely to be offered a settlement deal.

ACTION:
If you don’t want your FICO score to go down, do not ask for a settlement. A settlement means you failed to live up to your obligation to pay the full amount of debt you were responsible for. It will indeed have a negative impact on your credit score. That said, in certain rare instances—if you’ve previously had a stellar record,
have suffered a job loss or medical catastrophe, and the outstanding debt isn’t huge—you may be able to convince the card issuer not to report the settlement. Be prepared to document your case.

ACTION:
Be prepared to pay income tax on the amount of the forgiven credit card debt.

By law, the credit card company is required to send you and the IRS a 1099-C form that shows the amount of the forgiven debt, which is indeed money that you will owe income tax on. Sorry, there is no tax break for credit card settlements. (An exception is if you are insolvent, meaning the amount of all your liabilities is more than the value of all your assets. If the forgiven debt is reported to the IRS on a Form 1099, you should attach a note to your tax return explaining the insolvency—otherwise, the IRS will likely initiate an automatic audit, since the income reported on the 1099 does not appear on your return. Be prepared with good documentation to back up your claim that at the time the debt was forgiven, your liabilities exceeded the fair market value of your assets. I recommend you work with a tax advisor to help you navigate this situation.)

ACTION:
The best protection is a strong FICO score. When one bank fails, another bank takes on its existing credit card accounts. But you need to realize that the new bank is not required to keep offering you that card. It will investigate your account and decide if you are a good credit risk. And let’s be honest here: If your bank failed in part because it was too lenient about extending credit, it stands to reason that the acquiring bank may not want to keep your business. Bottom line: If you are a credit risk, your credit card could be shut down. If you have a strong FICO score, you will no doubt be welcomed by the new bank with open arms.

ACTION:
Of course you are still responsible for the debt. People, there is no shortcut around personal responsibility. You made the charges, so you are responsible for the debt you ran up.

Keep sending in your payments. Print a copy of the canceled check or e-payment and keep it in a safe place. Chances are the transition to your new bank will be seamless, but you never know. I think it is wise to keep a printed record for at least six
months after your bank has been taken over by another bank.

ACTION:
Improve your score to 720 if you want a loan with decent terms.

As I write this in late 2009, lenders are no longer eager to lend money to people with just so-so credit. That’s true of any type of loan: mortgages, car loans, private student loans. In the past (the days of irresponsible, subprime lending, circa 2007 and earlier), it was fairly easy for anyone to get a loan of any type. If you had a great FICO score (over 720), you got the best terms. But if you had a low FICO score, you could still get a loan, though you’d pay a higher interest rate and maybe higher fees. Now a low score can mean no loan. It’s the same issue we have been talking about over and over: Lenders are running for safety. They are very cautious about whom they will lend to. As of late 2009, a FICO score below 700 is likely going to make it very hard to qualify for a loan, or you will have to pay a steep risk penalty: much higher interest rates and fees than you might have paid with the same score two years ago.

At some point when the financial clouds clear a bit, lenders will ease their rules and offer better terms for customers with lower FICO scores. But you and I have no idea when that will happen. I can guarantee
you one thing, though: If you keep your score at 740 or better, you will always be deemed a great credit risk, no matter what mood lenders are in.

ACTION:
Know what matters to FICO and make the necessary changes in your financial life.

You actually have three FICO scores, one from each of the three credit bureaus: Equifax, Experian, and Trans-Union. Credit scores range from 300 to 850. A year ago, I would have told you that a score of 720 or better was all you needed to get the best loan offers. But the fallout from the credit crisis has meant that the top tier has actually been pushed higher; some mortgage lenders reserve their best rates for individuals with FICO scores above 740. Unless you plan on buying a house in the coming year, I wouldn’t worry as long as your score is at least 720. That’s still plenty good enough to keep most creditors happy.

If your score is below 720, here’s what you need to do to make it better:

• Pay bills on time. This accounts for 35% of your credit score. If you are late on payments—not just credit card payments, but bills of any kind, it will pull down your score. Pay on time, even if it is just the minimum due, and it will help your score.
  

• Reduce what you owe
  . We already covered this earlier in the chapter. The less you owe on your cards and other debt, the less “risky” you look to potential lenders. How much you owe relative to your available credit and other debts accounts for 30% of your score.
  

• Hold on to cards with a long credit history
  . The longer your credit record, the more data FICO has to assess whether you are a good credit risk. This accounts for 15% of your score. Make sure you keep your card with the longest history in good shape; you don’t want it to be canceled.
  

• Limit your credit applications
  . The more new credit you ask for, the more nervous you make lenders. New credit accounts for 10% of your FICO score. If your record shows you have applied for multiple credit cards and a new car loan at the same time, it will pull down your score.
  

• Don’t sweat your mix of credit
  . Lenders love to see that you can responsibly handle different types of credit—for example, credit cards and a car loan and a mortgage. But your mix accounts for just 10% of your FICO score. My advice is not to pay attention to this part of the FICO scoring system. I would never recommend adding a new type of debt just to address this part of the FICO calculation. Besides, you can easily have a credit score of 740 or higher with just a few well-managed credit cards.
  

ACTION:
Don’t fall for the come-ons. These offers are often rip-offs and can do serious damage to your credit score and leave you in more debt than you started with.

I know how tempting it sounds when you hear an ad that tells you the Super Duper Debt Consolidation Co. is standing by to make all your credit card debt stress go away. What they don’t explain is that they typically charge you 10% or so of what you owe to take on your case, and in the event they work out a settlement with your creditors, they are going to want another 10% or more of the amount they “saved” you. And I promise you, these debt-consolidation companies aren’t going to spend a lot of time explaining to you that any settlement they negotiate for you will ruin your FICO credit score and may end up costing you income tax on the amount of debt that is forgiven.