Out of debt. Now what?
January 15, 2011 6:56 AM   Subscribe

Mrs Supercres and I just came into some money (okay, she did) and used it to pay off our not-insignificant credit card debt in full (okay, mostly mine). Questions about credit scores, closing accounts, and moving forward are inside.

Call this a "healthy credit use" primer. Forgive any dumb questions, please.

Long story short: I was really bad a living inside a budget near the end of college and shortly thereafter, and racked up a fair amount of credit card debt, to the tune of $5k.

My older card was opened around May 2006; I got it because it was linked to my new local bank account and I wanted to build good credit history (oops). The newer one I opened a few months later when my bank stopped being associated with the first one. Naturally, my impulsive side saw "available credit" as "hey, free money!" and balances on both grew steadily.

Current interest rates are 13.99% and 7.24% on the older and newer cards, respectively. They now, thanks to the Missus, have zero balances (as do her store card and low-limit credit union card). (For what it's worth, she is just now starting to pay off her student loans; she was in school until recently. I don't have any.)

I've already cashed out the rewards points on both. (Helloooo $300 in Amazon gift cards; that was almost another Ask question.) I want to improve my credit score and general financial reputability going forward, so what should we do from here? Now that the money going towards balances is being saved, purchases like a new car or house don't seem as far off, so we're moving them to the front burner.

My first thought was to close the older higher-rate card. It's less convenient to use and pay; the newer card shows up on our online banking site. It's not that much older than the other one-- 4.7 years versus 4.4 or so. If I closed it, though, I feel like it would be best to get a limit increase on the newer card so that my available credit stays the same; they're both 3k, so I'd go from 3k on two to 6k on one. I don't want to get dinged for a rejected limit increase, though, so would it be better to talk to a human at my bank to tell them I'm closing the other card? Does available credit even matter for my credit score at all, or is it just about staying under ~30% utilization?

Second: how should we use the credit card(s) going forward? I always thought it was advantageous to put an easily-paid-off amount on the cards, but Mrs S disagrees. There must be some advantages; points, at the very least, and not having the bank cancel the card(s) due to inactivity. And is there marginal benefit to putting ALL monthly purchases on the card, versus just one shopping trip/big purchase per month? (Yes, we're going to be veeerrrrry careful with this.)

To head off any questions: I don't know my current credit score, nor does Mrs S. We just paid off the balances this week, so how long would I need to wait to make sure I'm getting the "out-of-debt" version of my credit report?

How else should we take advantage of this new-found financial solvency, with a mind to buying a house in the near future?

posted by supercres to Work & Money (21 answers total) 7 users marked this as a favorite
A quick tip I've heard from a couple financial people (I'm not an expert myself, but have heard the advice repeated): don't close credit accounts. Instead of getting rid of that card, just use it a couple times a month for something like a phone bill or groceries, and then pay it off at the end of the month.
posted by Help, I can't stop talking! at 7:13 AM on January 15, 2011 [1 favorite]

Don't raise your credit limit -- you have already demonstrated that you are sometimes a bad user of credit cards, so there's no reason to maximize your ability to screw yourself up. It's a lot smarter to amass some savings to cover unexpected expenses (and trust me, if you buy a house you will have some of those) rather than using the credit cards as protection from those expenses.

So that's part of how you use the credit card(s) in the future -- you only use them for things that you can pay off that month entirely. As a day to day (or month to month) thing, I think it's smarter to use cash or a debit card -- in other words, real money, not borrowed money -- for routine expenses like grocery shopping. Having really good rewards programs on the card can change that sometimes, but only if you can be 100% careful about not exceeding your budget.

You should also be making informed decisions (for example, your current credit score could be very high, we don't know), so you should pull in your free credit scores now to establish a baseline. If they are good, you can just ignore them from now on knowing that (assuming nothing changes) you will be able to get a good mortgage when you are ready to buy the house. If the score is terrible, then you can look at the reasons and see how to improve it over the same time that you would be saving for a downpayment, building up your rainy day fund, etc.
posted by Forktine at 7:24 AM on January 15, 2011

Best answer: Yes, what Help, I can't stop talking! said about not closing the account.

Just put the high interest rate card in a drawer. In another state, maybe. And from my experience, it takes years before a credit card will get threateningy about closing an inactive account. Just read the notices they send you, pretend the card doesn't exist otherwise, and move on.

You'll find that having the balances paid off will give you an instant jump in score (it did for me), but I'd wait until the end of the reporting cycle for your account before you actually pull your reports.

And it sounds like you're doing the right thing regarding moving forward. Save as much as you can. Open an ING account or similar and have an amount withdrawn automatically every week. It will build up quickly.

Just stay out of debt and don't sweat the small stuff. Mrs. S is right.
posted by clone boulevard at 7:25 AM on January 15, 2011 [1 favorite]

Couple of things- closing an account that you had trouble with won't remove it from your credit history, or have a positive effect on your score.

One of the big things that affect a credit score is the ratio of debt to credit that you have. Your credit rating is worse if you have $5000 in credit and a balance of $4000, than if you have $30,000 in credit and a balance of $10,000. Because what they want to see is if someone can manage their debt. If you are always maxxed out, they know you are on the edge, and the chances of them getting their money back are lower.

The other thing that matters is your credit to income ratio. They look at your income, your long term debts like mortgage (or rent), student loans and car loans, and then take what's left of your income and see if you would be able to manage more debt. So, suppose after those other long term debts, you have $1000 left over. But you have enough credit that if you maxxed it all out, your minimum payments would be $1200, you probably are going to have a low score.

My opinion is that credit cards are awesome for a variety of reasons. If you are 100% sure you can manage your spending, it is great to run everything you can through the credit cards. You can easily make a few hundred a year in rewards. As long as you don't put yourself into a situation where you pay (too much) interest or penalties, it is free money. And it is more convenient.
posted by gjc at 7:45 AM on January 15, 2011

My 2c, just make sure none of your current cards charge a yearly fee, if they do might be better to switch to a no-fee card. Also, this site, Creditkarma, has loads of free info about credit scores, cards, etc. once you register.
posted by freakazoid at 8:27 AM on January 15, 2011

1) Put your credit cards into a big bowl of water

2) Put the bowl into the freezer

This should discourage you from using your credit card in the future.
posted by jchaw at 8:28 AM on January 15, 2011 [1 favorite]

supercres: "I don't want to get dinged for a rejected limit increase, though, so would it be better to talk to a human at my bank to tell them I'm closing the other card? Does available credit even matter for my credit score at all, or is it just about staying under ~30% utilization?"

Well, besides the obvious "increasing available credit and not using it automatically improves utilization" approach, I don't believe available credit is reflected in FICO scores. It might be worth spending 20 bucks to find out what your credit score is once your creditors report the payments; my report came with advice showing where I was dinged and how to improve. I actually found it quite relieving to find out that whereas my parents were saying I was an X because I had no history, I was actually 800, because of student loans and a discover card I got from an aggressive telemarketer in college that I'd never touched but remained open.

And is there marginal benefit to putting ALL monthly purchases on the card, versus just one shopping trip/big purchase per month? (Yes, we're going to be veeerrrrry careful with this.)

In my experience yes, but it's over the course of a year, not month. In a given year, I get like .25 percent cash back on the first 3k, and 1 percent on purchases above that (I hate miles/points programs). My card also runs a rotating bonus category at 5 percent cash back, which is nice. Anyways, yes, you get more points for more purchases, so there is a marginal benefit.

This all said, I think you might owe your wife a few months of planned austerity: prove you can budget and live without credit cards, only then should you be considering the minor upsides to living through credit. This is easy for people like me who save by default and stress about major purchases, and difficult for folks who spend a lot of time anticipating the new iPhone etc. And never carry a balance, since that financing charge will demolish your rewards in one fell swoop.

Finally, if you're going to buy a house, you need to start building up savings. If you have a Roth IRA, you can take like $10k worth of earnings out of them after 5 years for a downpayment on a qualifying first house. And you can also pull your contributions out at any time, like I did in 2007-2008 to make rent. Not a great use of funds but that's grad school for ya. At least the market timing was great.
posted by pwnguin at 8:47 AM on January 15, 2011 [1 favorite]

I think that credit scores are calculated based on available credit, so closing a card without raising a limit on the other card would have a negative impact, but I'm not positive about this. However, I also think that this is a fairly minor bump down on your credit score, and the increase from no longer being in debt will outweigh this.

I did want to answer the question about how to use your card in the future - you don't need to USE the card in order to maintain a credit score. And very few places will close your card if you never use it. I have two cards that have been open for several years that I haven't used at all. I think that since you have had issues with keeping balances on cards, you should either stop using your credit cards for a while and instead use debit or cash OR you should be very careful about what you put on your credit cards and only put necessary purchases that you KNOW you have money in the bank for and pay off your credit cards every month. NO balances. Otherwise you'll go right back into your old pattern of debt. Sorry for lecturing, but I've known several people who have had a windfall like this, used it to pay off debt, and then gone right back into the same pattern, and I wouldn't want that to happen to you.
posted by echo0720 at 9:05 AM on January 15, 2011

I don't believe available credit is reflected in FICO scores

It is. On the page you linked to, one of the criteria considered is "How much of the total credit line is being used on credit cards and other revolving credit accounts."
posted by grouse at 9:19 AM on January 15, 2011

grouse: "It is. On the page you linked to, one of the criteria considered is "How much of the total credit line is being used on credit cards and other revolving credit accounts.""

That's known as the utilization rate, no?
posted by pwnguin at 9:48 AM on January 15, 2011

Response by poster: Thanks for the great responses so far.

I do appreciate the mini-lectures about not falling back into bad habits. I didn't mention this, but I've been in "decreasing balances only!" mode on the CCs for almost a year now. I haven't put a purchase on them in a long time. Funny enough, getting out of debt is what's making me think about starting to use them again. And now I have someone looking over my shoulder-- Mrs S and I have combined finances, and she's an authorized user of my card.

I guess I'll keep them all open, but only use the most convenient, lowest-rate card, and to only use it on things that are already in our budget like bills and groceries. I also set up full-balance autopay-- I'm thinking it'll keep us honest.

Thanks again!
posted by supercres at 9:49 AM on January 15, 2011

Best answer: Congrats on digging out of credit card debt. After I paid off mine, I got an AmEx Blue Cash card and started putting all monthly purchases on it, to get the cash back. I'm careful to pay it off in full each month; I'm determined never to pay another dollar of interest to a credit card company. They can pay me for a change.

I want to put in a plug for the Motley Fool's Credit Card & Consumer Debt board, which is a great place to ask this kind of question and/or read and learn. One thing I learned from that board is that, when people are able to pay off card balances because of a windfall (like the money your wife came into), they may not have totally broken the bad spending habits and living above their means that led them into debt in the first place. It sounds like you've seen the light in terms of following a budget, but you may want to try making a few small purchases a month on the cards and paying them off before using them for all monthly expenses right away -- just to develop the new rhythm.
posted by southern_sky at 10:11 AM on January 15, 2011

I guess I'll keep them all open, but only use the most convenient, lowest-rate card.

Let's be clear: if you're doing this properly, interest rate has no bearing on which card to use. My stated interest rate is 12.99 percent, but since I autopay full balance every month, I am charged no interest on purchases I made in those 30 days. There's some benefit in leaving a bit more money in savings over this period, but the interest rate at the moment makes this not really worth thinking about.
posted by pwnguin at 10:11 AM on January 15, 2011

The full-blown Dave Ramsey approach is to cancel them both immediately and never use them again. He makes a good case for that, actually - www.daveramsey.com if you're interested.

If you're not interested in being that gonzo, I would at least advocate - learn to budget and live without ever using them. Quaint notions like SAVING money for things that don't fall inside current cashflow, that sort of thing.

Not using the credit card will not hurt your credit. You'll be fine with a couple of zero balance credit cards on your credit score for the foreseeable future.

Were you late on these credit cards at all? I don't see anything in your question or follow-ups regarding this. If you were making the payments all along and your balances were diminishing, your credit may not be that bad as of now.

Finally, I would be careful about assuming you can afford bigger and better things (house, car) because you no longer have the payments. I once had credit card bills and now I don't, I've also reduced my car payment expenditures substantially and - guess what? It's not the magic pill you might think. When I had the bills, I was also charging stuff. When you commit to not adding debt and really put the onus for anything you might want to buy on your income and what you can save, your perspective changes on your cash flow. Give it a few months at least before committing yourself to a new payment on something. I'm not totally against buying durable goods on installments, but hey, you may find you enjoy the flexibility of not having payments. Only take on a car payment, for example, if you have enough income to live AND have a cushion AND save for retirement, etc.
posted by randomkeystrike at 10:11 AM on January 15, 2011

Response by poster: Let's be clear: if you're doing this properly, interest rate has no bearing on which card to use.

Crystal :-) That's why I mentioned it being more convenient. Though now that I think of it, if I'm religious about paying it off, perhaps it might be useful to shop around and trade my low-ish rate for better rewards. I'll have to check out the links posted above in more detail.
posted by supercres at 11:27 AM on January 15, 2011

Response by poster: And I was always on time with CCs, bills, etc. My credit score isn't bad, and I'm not looking to push the envelope either, but I would like to improve it.

Our current budget has a good chunk of money going to savings- an ING account. Even before we were out of debt, we had almost as much going to savings as paying down balances. Now that we're also paying student loans, we can't quite double amount going into savings, but we can get close.
posted by supercres at 11:30 AM on January 15, 2011

Regarding your house plans, make sure you have a really good buffer in your savings before buying. You say you were struggling to repay $5k on the credit cards -- that's a really cheap new HVAC system, most of a sewer line, about half of a roof, or perhaps a quarter of a serious foundation repair. Houses can be crazy expensive to maintain and repair, much more so than buying it in the first place.

This gets back to how you use the credit cards and what their role in your life is. The credit can be a nice safety margin for an emergency, but a lot of contractors don't take credit cards, and those bills can easily exceed the low limits you have right now.
posted by Forktine at 11:42 AM on January 15, 2011

Mrs. Supercres here! We have no plans to get a HOUSE in the near future. We have about a 10-year plan for that (should line up nicely with spawning), which includes leaving a nice chunk in savings in the bank after a good downpayment. Our car is doing OK, but may need replacement in the next 5 years or so.
posted by two lights above the sea at 12:16 PM on January 15, 2011

Best answer: If they have rewards, use them for things that you have the money in the bank to buy. Not things that you'll have money in the bank next week to buy, not things that you'll have money in the bank tomorrow to buy, but things that you could plunk down your debit card to buy right now. The only exception might be large purchases at some place like Best Buy when they're running an 18 month no interest deal and you have most of the money in the bank already and can pay 1/18th the cost of the purchase from income each month.

Basically, your rewards card becomes your debit card.

Don't close either card, because even if you pay off your balance each month, whatever you've charged will show up as a balance on your report, and you want that balance to be less than 15% of your available credit across all cards (and preferably less than 15% of the credit line on that one card, too!)

Besides, you never know when some crazy zero percent thing will come along and enable you to make some free money by plunking the "balance transfer" in a savings account.

If you can't control yourself, listen to Dave Ramsey, but his advice is really quite terrible for getting the best rates on loans. Of course, his whole schtick is that using his advice you'll never need a loan for anything. That may be true, but there are times when you might want a loan for a financially rational reason. Automakers often lend money at less interest than what you can make in a CD. Getting the absolute best rate on a mortgage loan will save you more money than any other financial decision you make.

Following Ramsey's advice basically means you can't get the best rate on a loan for anything, since your credit score will be limited. Or the best rate on insurance.

Thus, I think credit cards are great to have, even if you have to leave 'em in the sock drawer to keep from using them. Better to not get the rewards than pay a bunch of interest to the bank that will more than outweigh your rewards earnings.

FWIW, when it comes to buying a car, the key is to buy used and also to not stretch your budget. There's nothing wrong with a payment, but it should be comfortable enough that you can continue to save while paying it. And to have a low enough loan balance that you're never upside down on the car. Ever. That's a terrible situation to be in. If your car is worth more than your loan balance and it gets totaled, you will have a down payment for another one if you need it, without dipping into savings. If your car is worth no more than what you owe, or worse you're upside down, in the best case you have no car and no loan and no down payment. In the worst case, you have no car and no down payment, but still have a loan. Bad place to be.
posted by wierdo at 1:42 PM on January 15, 2011 [1 favorite]

I was always on time with CCs

If you think that, then you are thinking about your credit cards the wrong way. Think of yourself as being on time only if you are paying off the entire balance every month.
posted by grouse at 1:58 PM on January 15, 2011 [1 favorite]

Set up one small bill to autopay to each card, then set up that card to autopay in full from your checking account every month. That should keep you in the ideal utilization range of greater than 0% but less than 10% and boost your score.
posted by Jacqueline at 11:12 AM on January 17, 2011 [1 favorite]

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