There are key moments in life when putting away the cards and paying off any balances can be the best moves for your financial future
Credit card debt doesn’t take long to spiral out of control (thanks a lot, compound interest!), and that’s under normal circumstances. When you add financial milestones and other life situations to the mix, there are periods when it makes sense to give plastic a timeout.
“People who end up in trouble, meaning with bad credit scores, can usually trace it back to a time in which they overused their credit cards,” says Ken Chaplin, senior vice president of TransUnion Interactive (one of the three major credit bureaus, along with Experian and Equifax).
These are six moments when the right move is to shelve your cards and take a credit card timeout:
1. When you plan to apply for a home loan
If you’re in the market for a new home loan or want refinance a mortgage, lenders will look at both your credit score and your debt-to-income ratio, says Katie Moore, certified consumer credit counselor at GreenPath Debt Solutions, a credit counseling company. “If you’re carrying high balances, your credit score is going to be impacted,” she says.
In the months before applying for a home loan, don’t increase your balances or open new lines of credit, says Chaplin. Paying down high balances should be your No. 1 priority. “A score hit might prevent you from getting the things you want,” he says — in this case, access to the best mortgage or refinance terms. Missing just one payment or buying new furniture on credit right before you try for a mortgage could lower your score, affecting your application.
When you start thinking about buying a house, your first focus should not be on picking out a dream home, but on putting yourself in the best possible credit standing, says Kevin Murphy, senior financial services consultant at McGraw-Hill Federal Credit Union. “If you have strong credit, you’re going to call the shots. When your credit has suffered, you’re going to have to accept whatever loan you can get, if you can even get one,” he says.
As for refinancing, being qualified for a loan a few years ago doesn’t mean you’re a shoe-in this time, Chaplin says. “A refinance is viewed as a brand-new event, so you’ll want to be putting your best foot forward from a credit standpoint so lenders will feel more confident in you, and you’ll be able to get a lower interest rate,” he says.
2. When your credit utilization gets high
Using too much of your available credit will hurt your credit score. While 30 percent credit utilization is often cited, there is actually no red flag number at which debt utilization suddenly hurts your score. It’s a sliding scale, and the closer it is to zero, the better. The best credit scores belong to those with a credit utilization of 7 percent or lower, according to FICO, the creator of the most widely used score. If it gets far above that, it’s time to go on a spending diet and focus on paying down your card.
If you’re carrying balances on multiple cards, it’s easy to lose track, says Moore, so start by really examining your accounts to see where you stand in terms of debt utilization. “The biggest warning sign that something is going on with your budget is if your balances are consistently increasing,” she says. If that’s the case, cool it with your cards.
And, if you happen to score a nice lump sum of cash (say, a bonus or tax return), apply that right to your credit card balance for a quick credit rating boost, suggests Murphy. “You’ll see a positive hit to your FICO score in about 60 days,” he says.
People who end up in trouble, meaning with bad credit scores, can usually trace it back to a time in which they overused their credit cards.
|— Ken Chaplin|
Senior vice president, TransUnion Interactive
3. When you can only afford minimum payments
Somebody who’s only making minimum payments is probably in pretty rough shape financially, says Albie DiBenedetto, education and development associate for American Consumer Credit Counseling, a national nonprofit financial education organization. “The vast majority of the minimum payment amount is going toward interest,” he says. And, if you continue to charge, your balance will never go down. In short, cease using plastic and pay more than the minimum if you want to put a dent in the principal.
4. If you’re in a constant state of buyer’s remorse
Shopping with a credit card is a different thought process than paying with cash. At the moment, it may not feel as if you’re really spending money. But later, the guilt pangs (and the bill!) come, and they’re trying to tell you something. “If you’re not being as disciplined as you feel you could be, it might be a sign that you’re not using credit for its true intended purpose, which is convenience, and instead, using it as if it were income,” Moore says. At that point, put away the plastic. She says, “You can’t overspend the cash in your pocket.”
“If you’re in a vicious cycle of ‘spend, pay back, repeat’ to a point where it’s out of control or you have too many cards to manage, that’s when it might be better to take a couple of steps backward credit-wise and close some of your cards,” says Murphy. Keep just one or two for emergencies, choosing the ones you’ve had the longest, and/or those with the better interest rate, he adds.
5. When your marriage could be on the rocks
When divorce happens, more attention may be given to which spouse gets what asset, but equally important is how debt is divided. One of the biggest causes of post-breakup strife is the failure of one party to pay off debt as directed by the divorce decree, so the less of it there is to divide, the better. “It’s good practice to get joint cards paid down and cleaned up, and if possible, sign up for individual credit if divorce is imminent,” Chaplin says.
Eliminating joint account balances is especially important to making a clean split, says Moore. Nixing your individual plastic purchasing for a while is probably best as well if you see a break up in your future. “You don’t want to add on more debt obligations when you might be going down to one income,” she says.
6. When debt collectors are calling
When people start having trouble paying one credit card bill, they may start relying on another. And another. Soon the debt collection calls follow. “That’s when it’s time to seek some help,” says Moore. “If you’re not really paying anything off and just shifting where your debt is going, you’re not addressing the root issue.”
Debts “tend to haunt you and impact things you may not realize, down to getting a job or apartment to rent,” says Chaplin. Instead, communicate with your creditors early on, so they can work with you before they send your debts to a collector. Facing the problem means changing your spending habits, and working out a payment plan so that the account doesn’t show a lengthy record of delinquency, which hurts credit scores more than a missed payment or two.
“If you’re in severe crisis with credit, there are resources out there to help,” says Chaplin. Accredited nonprofit counselors from the National Foundation for Credit Counseling or the Association of Independent Consumer Credit Counseling Agencies are a good starting point.
7. If you plan to file bankruptcy
Claiming bankruptcy is a last resort, but if you know you’re approaching that option, you need to cease credit use. “One of the things that bankruptcy court will typically ask is if you have been recently charging,” says Moore. In other words, did you go and charge a fur coat before heading into bankruptcy, knowing full well you would never pay the debt? Those debts may not be discharged — meaning you will still owe them, despite filing bankruptcy. And it could get worse: “It can amount to theft if you take out a loan you don’t intend to pay back,” says Chaplin.
Putting yourself in a credit card timeout doesn’t mean you can never use plastic again. But shelving your cards while you work to improve your credit score, pay down a debt or better position yourself for a major life transition could be the best thing you ever do for your finances.