Protecting your credit score when paying down debt

To Her Credit columnist Sally Herigstad
Sally Herigstad is a certified public accountant and the author of "Help! I Can't Pay My Bills: Surviving a Financial Crisis" (St. Martin's Press, 2006). She writes "To Her Credit," a weekly reader Q&A column about issues involving women, credit and debt, for, and also wrote for MSN Money, and, and has guested on Martha Stewart Radio and other programs.

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Question for the expert

Dear To Her Credit,
Hello. We would love your advice. To date, my new husband and I have a combined total of about $40,000 in credit card debt. We both came into the marriage with significant balances, but we have worked hard over the past three years to make payments on time, chip away at the debt (that $40,000 number used to be a bit bigger), and improve our credit scores.

In January, a family member of mine passed away. Sometime this year, we will receive an inheritance that will help us eliminate this debt. We are so excited for this fresh start!

I'm worried, however, because when I paid off a credit card a few months ago that had a $2,000 balance, the creditor sent us a letter after the fact reducing our credit limit significantly (from about $10,000 to $500) -- which decreased our credit score. We were penalized for paying it off! So my question is this: How do you recommend we reduce this debt? All at once? By making a few large payments? We want to pay off our debt, not damage our credit scores in the process. Thank you!

-- Jennifer

Answer for the expert

Dear Jennifer,
It's possible that your creditor reduced your credit limit as soon as they saw you had paid off the card -- thus preventing you from running it up again. However, you had a $2,000 balance on a $10,000 card, so it's not as if they were preventing you from increasing your balance before. More likely, your credit limit reduction had nothing to do with you and everything to do with the general tightening of credit going on everywhere now.

Cathy Pareto, a financial planner with a master's degree in business and president of Cathy Pareto and Associates, says, "It may be that the credit card company did a regular review of their credit history and possibly discovered their high debt load. Card companies do review clients' histories on a regular basis to ensure that customers are still creditworthy. So the timing may have just been coincidence." Pareto has seen credit limits going down for no reason at all.  "Additionally, because of the current economic environment and the specific burden on banks lately, many credit card companies are simply reducing or closing lines of credit across the board," she says. "They may have merely been caught in that net."

Chances are, your other credit card issuers will not reduce your credit limits when you pay off your cards. In fact, your lower debt load after you pay your cards off should make you appear more creditworthy. "Having a zero balance should not negatively impact your credit score, it should improve it," says Pareto. "Remember that your credit score depends on a variety of factors -- including your credit mix, your rate of credit utilization (the amounts you owe relative to the limit), the number of cards you carry, the length of your credit history, etc."

The thing that concerns me more than your credit limits or credit score right now is the outrageous amount of interest expense you're paying. Your interest expense on $40,000 could be $400 to $800 per month. I'd get checks out in the mail this afternoon to put a stop to that! Pareto says, "I always recommend that debt be paid off as soon as possible.  Why chip away at a pile of debt if you have the cash on hand?"

Before you run those checks to the mailbox, make sure you're saving enough for an emergency fund. Not having an emergency fund is the most common financial mistake people make -- and it's the reason they get right back into debt the first time their car breaks down, they need a root canal, or any other expense comes up. Put enough money to cover three months' living expenses somewhere so you can get to it if you have to.

Good luck with your financial "fresh start" -- and here's hoping that from now on you can use your credit cards as payment tools, not long-term loans. If you always do that, you should seldom have to worry about credit limits again.

Take care of your credit!

See related: Lending standards keep tightening, Fed says, Your keys to getting in the 700-plus credit score club, Beware, cardholders: The terms, they are a-changing,

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Updated: 11-24-2017