Suze Orman, financial expert and host of the award-winning “The Suze Orman Show” on CNBC, says that 2009 is a critical year for your money. There are safeguards to put in place, actions to take, costly mistakes to avoid, and even opportunities to be had so that you are protected during the bad times and prepared to prosper when things take a turn for the better. In this excerpt from her book “Suze Orman's 2009 Action Plan,” she answers questions about credit.
Chapter three: Credit
The new reality
The banking industry is running scared. They think you won’t be able to keep up with your credit card payments in 2009 as the nation continues to work its way through this economic meltdown. Of course, that’s a justifiable concern whenever the economy slows down, jobs are lost, and unemployment rises. But what’s different in 2009 is that banks are already reeling from the mortgage-default crisis that has triggered bank failures and shotgun marriages between weak banks and less-weak banks. Banks aren’t exactly in great shape these days and they are painfully aware of a Category 3 hurricane about to bear down on them: National credit card debt is at a staggering $970 billion, 50 % higher than when the last economic slowdown hit in 2000. That’s what happens in an era of “easy” money where banks irresponsibly hand out multiple credit cards to anyone with a pulse, regardless of income, and consumers are all too eager to play along.
The game, however, is up, my friends. Credit card companies have reversed course. They are now looking for ways to lend less money, especially on accounts they deem risky: consumers with high unpaid balances and poor FICO credit scores. Reducing credit card limits, closing down accounts with no warning, and abruptly increasing interest rates are just some of the aggressive tactics the card companies are implementing right now to shore up their business. That means serious repercussions for you throughout 2009. Your FICO score may drop — not because you changed your financial behavior, but because the credit card companies changed the rules on you.
The best way to insulate yourself is to get out of credit card debt once and for all. If you pay off your balance, you don’t have to worry about the interest rate on your card. If you pay off your balance, you are less likely to have your credit card limit reduced; and even if it is reduced, it will not have a negative impact on your FICO score.
If you pay off your credit card balance, you can focus on building an emergency savings fund. That’s especially important in 2009. The days of using your credit card as a de facto emergency fund are over. If you tap too much of your credit card line, it is likely you will see the line reduced, your interest rate rise, and, yes, potentially have your card closed down — and there goes your FICO score. Unpaid balances in 2009 will put you in the middle of a vicious cycle. You must get out of card debt now. It is the number one action to take in 2009.
What you must do in 2009
- Make it a priority to pay off your credit card balances.
- Read every statement and all correspondence from your credit card company to make sure you are aware of any changes to your account, such as skyrocketing interest rates.
- Work to get your FICO credit score above 720.
- Be very careful where you turn to for help with credit card debt. Debt consolidators are often a very bad deal. The National Foundation for Credit Counseling is a smarter choice.
- Resist the temptation to use retirement savings or a home equity line of credit to pay off credit card debt.
Your 2009 action plan: credit
Your 2009 action plan: credit
Action: Paying the minimum in 2009 is not good enough. Credit card companies are anticipating that as the recession plays out, consumers will be hard-pressed to keep up with their bills. So even if you have paid on time in the past, they are worried about what will happen in the future. And the fact that you pay just the minimum is a huge warning signal to your credit card company. It’s a tip-off that you may already be on shaky ground.
Paying just the monthly minimum due signifies to a credit card company that you may fall behind on payments in a severe recession and that you are also more likely to let your balance grow if you hit hard times. And that’s the last thing they want in 2009. To keep you from doing just that, they cut your credit limit.
Situation: You are worried that a lower credit limit will hurt your FICO credit score.
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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.
Situation: The credit card company canceled your account. Do you still have to pay the remaining balance?
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.
Situation:Your credit card has been canceled and you are worried it will hurt your FICO score.
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 most 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.
Situation: You thought the interest rate on your credit card was fixed at 5%, but it just shot up to 30%!
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.
In 2009, you better believe more and more credit card companies are going to jump to increase a low rate on a credit card if you make them nervous in any way. And just to be clear: An unpaid balance makes them nervous. Paying the minimum makes them nervous. Seeing you fall behind on another debt payment or missing a payment makes them nervous big-time.
I Video: Suze Orman’s financial tips for 2009 (on this page) f you want to steer clear of being hit with a giant rate hike, you have two options: don’t run up a balance in the first place; or, if you do have an unpaid balance, get it paid off. When you have a zero balance, what do you care about the interest rate?
Situation: You have a low-interest-rate credit card you never use — it is just there in case of emergency. Now you’re worried that if you have to use it, your interest rate will go up.
Action: Build a real emergency savings account. Relying on your credit card to bail you out of emergencies is too dangerous in 2009. (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 in 2009 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. The only solution is to stop thinking of your credit card as a safety net if you run into trouble. The only true safety net is a savings account.
Situation:You have a FICO credit score above 720 but your interest rate just shot up. What’s the best way to pay off your credit card debt?
Action: See if you can apply for a balance transfer to a low-rate card. Because you have a high FICO score, you may be in luck. But lenders aren’t exactly rolling out the welcome mat right now, so this may not be feasible.
Go to cardtrak.com and use the Search tool to shop for balance-transfer offers. The idea is to move your money to a card with a low introductory rate and then push yourself to get the balance paid off before the low rate expires. This can be tricky in 2009. You have the added risk that even if you do everything right with your new card, you could still have the introductory rate rescinded because something out of your control happened on one of your other accounts, such as having your credit limit reduced. In “Action Plan: Spending,” I explain how to reassess your family’s income and expenses to find more money to put toward paying down credit card debt.
Situation:You have a low FICO credit score, but you are current on all your accounts. How should you deal with your debt?
- Pay the minimum amount due on every card each month. That’s your only shot at keeping your FICO score from falling further. It will also lower the odds that your credit card company will close your account.
- Line up your cards and put the card that charges the highest interest rate at the top of the pile. That’s the card you focus on paying off first. Send in as much money as you can each month to get that balance down to zero.
- Once the first card is paid off, focus on the second card in your pile: the card with the next-highest interest rate.
- Keep up with this system until you have all the cards paid off.
- Of course, the big challenge is finding extra money every month to put toward paying off your credit card debt. In “Action Plan: Spending,” I have suggestions about how to “find” more money in your month by reducing your expenses.
Excerpted from "Suze Orman's 2009 Action Plan" by Suze Orman. Copyright (c) 2008, reprinted with permission from Random House. Download a free copy of Suze's book here.
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