Will a closed credit card account affect your credit score? How should one go about purchasing their first home? Is it better to pay off credit card debt or build up one’s savings? TODAY financial editor Jean Chatzky, CNBC’s Carmen Wong Ulrich and David Bach, author of “Start Late, Finish Rich,” offer advice on these timely issues, plus wise words about protecting your credit, investing and more:
Q: I recently had my credit card limit lowered on one of my cards. After a couple of months I received a letter that the credit card company had decided to close my account. I always pay my bills on time and always pay $50 to $100 over the minimum. Will this affect my credit score? — Veronique
Jean Chatzky’s answer: The fact that the company shut down your card will affect your credit score, but this isn't something that you won't be able to bounce back from. Your credit score is made up of five areas: 35 percent is based on your payment history — which is why you need to pay your bills on time — 30 percent is based how much credit you're using versus how much you have available, 15 percent is based on the length of your credit history, 10 percent is based on new credit you take out, and 10 percent is based on the mix of credit you have — in other words, the more variety, the better your score.
The two areas that are going to be affected by this closed card are the length of your credit history and the amount of credit you're using (your utilization ratio). If this is a card that you've had for a long time, your credit history will be shortened, and that can ding your score a bit. Unfortunately, there's not much you can do about that, except hang on to your other cards by using them once or twice a month for small purchases and paying them off in full. By the way, in this economy, this is what we all should be doing with our credit cards to avoid facing Veronique's situation.
Your utilization ratio is also affected, because when they closed that credit card, the amount of credit you had available on that card — the credit line — was taken away from you, and as a result, your ratio of debt to credit was decreased. A quick fix for this is having the credit limit on one of your remaining cards increased, if your lender will allow it (it's certainly worth a call).
Question:I am 27 years old, single with no dependents. I have my emergency cash fund set up and am debt free. I currently contribute enough to my 401(k) to max out my company's match. Now I would like to purchase my first home. The problem is I'm not sure how to invest the money I save for a down payment. I've read about Roth IRAs and money market accounts, but I'm still confused. I don't want to borrow from my 401(k). What should I do?— Tara
David Bach’s answer: I would put the money in an FDIC money market. Go to a major bank like Wells Fargo, Bank of America, Citibank or TD Bank, ask for a new account "special rate"— some are as high now as 3 percent — or save now with an iBond (savings bonds.gov), but that money needs to stay there for at least a year; rate is over 5 percent.
If you put it in a deductible IRA and make a one-time withdrawal of up to 10,000 for a first time home with no penalty.
Question:I have maxed out all of my credit cards. I have heard you talk about calling creditors to get the rates reduced, but I also hear ads for debt consolidation. What do you recommend?— Aaron
Carmen Wong Ulrich’s answer: Always avoid those debt consolidation ads! They charge you a lot to do what you can do yourself or with the help of a nonprofit credit counselor. Yes, you can call your lenders to get your rates reduced, but the odds are that they won't comply. These days, creditors are just as pinched as we are, so they're doing all they can to make a profit, which means raising rates, especially on someone who has maxed out their credit. First place to go: a nonprofit credit counselor. Find one near you at NFCC.org, the National Foundation for Credit Counseling. For a small fee, they will work as your advocate to do two things: talk to your lenders to work out an affordable plan and work with you to budget your payments as best as possible to pay down the debt.
But ask yourself too, why and how did you get into so much debt? You need to get at the root of the problem to make a decision with a counselor as to if you need to take more drastic steps. For example, if these are medical bills running you under, you may want to consider bankruptcy or settlement.
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Question: Due to a dramatic decrease in income last year, I was forced to live on credit cards. Now I have a $30,000 credit card debt. My income has now taken a huge jump. Should I pay off the credit card debt with my extra income right now or build up savings? I work on commission and do not know how long my income will be at the current level.— Mike
Jean Chatzky’s answer: Mike, if you don't have an emergency fund, that is first priority right now. You need to have at least six months’ worth of living expenses in a liquid savings account, so if your income does drop — or, worst-case scenario, you get laid off — you have some cushion to work with and you don't have to rely on that credit card again. That's how you avoid getting into debt in the first place.
Once you've established that, then by all means, start throwing as much money as you can toward those credit cards, starting with the one with the highest interest rate and working your way down, paying at least the minimums on all of them on time each month.
Question: We just had American Express call and they lowered our limit to about what we owe on the card. My question is: Can I call them and plead my case? We have been paying on the card triple the minimum payments and concentrating on paying the balance down. We have not been using the card, only in emergencies. The balance has been from college expenses and housing upgrades in the past. Also, should we cancel the card in response to the lower limit? — Todd
Carmen Wong Ulrich’s answer: Todd, you can always call a lender to ask them to change your terms, but as we're seeing with hundreds of calls and e-mails on the show, credit card companies are not budging. Card companies are under considerable duress right now — they're looking at record default rates (up to percent), so their response is to make as much money as they can right now. It's nothing personal! But it surely can hurt, especially if you have a long relationship with a card. What AMEX is doing is called "chasing the balance" — other card issuers are doing the same thing. They lower your credit limit to just above your current balance, which means you can barely use your card unless you pay all of it or a chunk of it off. You've been deemed a risk by the issuer, so they're limiting their risk of your taking on more debt and defaulting by chasing your balance down — and they may do it again!
Don't cancel the card — you need a good, long, strong credit history to have a great credit score. What you can do is pay down the balance as much as possible and only use the card for items that you can pay off in full every month. This will raise your credit score, making you seem less a risk for card issuers, and they'll raise your limits.
Question: My son applied at three private colleges. Two of the colleges awarded my son small grants and a manageable financial aid package. The third, which is the most expensive, only awarded him two small grants, in addition to federal and state aid. Of course, the third school is my son's dream school. Can I "plead my case" to their financial aid office, and what is the proper way to go about this? — Beth
Jean Chatzky’s answer: Beth, you can plead your case to the financial aid office, but you need to go about it in the right way. First of all, recognize the differences between these three schools, because that could easily account for the differences in aid packages. If the schools are comparable in quality and attract the same kinds of students, you'll have a better chance of getting them to re-evaluate.
Then, do some research. Did the first two schools ask you for any information that the third school didn't, or vice versa? Some schools will take home equity into consideration, for instance, while others won't, and that can make a big difference in your reward package. Your success in large part is going to depend on your understanding of how the school arrived at your financial aid package, so you really need to retrace your steps.
Once you've done that, make an appointment with the financial aid office and present the information to them. Let them know that this school is your son's first choice, but other schools offered him more money. Most schools won't come right out and say that they match the financial aid packages of other universities, but if the universities are similar in quality, they may be willing to jiggle some numbers around to help you out, particularly if you're able to provide them with more information about your financial picture (at some schools, even a detailed list of your high monthly living expenses is enough to prompt them to open your file). At the very least, it's worth a try.
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