Help! I'm buried in bills and my credit is bad

Here's a scary statistic: the average American family has more than $8,000 in credit card debt divvied up on 16 different cards. That doesn't include debt from the mortgage, student loans, medical bills or anything else. Jean Chatzky gives tips over that'll help get rid of your financial burdens. Here’s an excerpt from her book, “Pay It Down,” that gives examples of two families struggling with debt:From Step 3: Know and manage your credit score
Tales of Life and Debt:
Recovering from a Lousy Credit Score, Dollar by Dollar
Back in the fall of 2001, Lydia and Brian, a two-career couple in Washington, D.C., decided they wanted to build a house. They found a builder they wanted to work with, a subdivision in suburban Maryland in which they wanted to live and — excited at the prospects — went about prequalifying for a mortgage. All of a sudden, their bubble burst.

Mortgage rates at the time were near historic lows. Lydia and Brian were counting on using those rates to help them buy a house big enough to grow into. But their potential lender told them they would be able to qualify only for rates two to three percentage points higher. Why? Lousy credit scores — between 580 and 620, to be more precise.

“We knew we had six to nine months before the home was ready — we were building from the ground up,” explains Lydia. “So we decided to take the time to work on improving our credit scores and our overall financial situation.”

The first thing they needed to know was what, precisely, was dragging their scores down. They pulled both their credit scores and their credit reports. Without too much detection work, they found the culprits. “One reason our credit scores were so low was that there was a lot of outdated information on our credit reports,” Lydia explains. Accounts had been closed. Late payments that had occurred more than seven years earlier should have already dropped off the report.

Lydia and Brian took matters into their own hands, sending certified letters to all three credit reports disputing the information and noting, specifically, which items should be updated and which should be removed. “It took us some time to clean up those credit reports,” Lydia recalls. “I also called or wrote to the various creditors to make sure they updated their records.”

The other reason for the couple’s low scores was hidden in their bulging wallets: 12 credit cards, each used to 50 percent of its limit — or more. That made the couple’s debt-to-income ratio — an important component of their credit scores — higher than it should be.

No amount of letter writing, even certified letter writing, could take care of that. Instead, Lydia and Brian had to hunker down. They decided to forgo eating out as much as possible. They cut back the money they were spending on clothing and travel. They began to dump every available penny into a money-market account, which they then used to pay off their credit cards. Over the next nine months, they paid off 11 of 12 credit cards — and, to eliminate temptation, closed 7 of them. They then stopped using credit cards completely and saved an additional $10,000 to put down on their home.

When they went back to their lender several weeks before they closed on the house, he was astonished to see the difference in their credit scores. They had jumped to between 650 and 730 points. The result: Lydia and Brian qualified for a three-year adjustable rate mortgage at 4.95 percent. With their old scores the rate could have gone as high as 7 percent; their nine month exercise in frugality saved them $400 a month on their mortgage payment — nearly $5,000 a year.

To this day, Lydia and Brian pull their credit scores every six months to make sure they’ve remained high, an exercise that has continued to pay off. In August 2003, they refinanced their mortgage at a fixed 5.75 percent for 30 years. At that time, their home was appraised at $100,000 higher than its original appraisal. “I am an example of a person who learned how to repay her debts,” says Lydia, proud of her achievements. It wasn’t easy, but she did it — step by step, dollar by dollar. Without professional help.

From Step 4: Track your spending
Tales of Life and Debt:
“We Didn’t Know How Much We Spent!”
“I wasn’t very well educated in the world of money,” says Al, a project manager for a telecommunications company in Atlanta. “And that made it one of the most difficult topics for me to talk about. I never asked my parents how much they made. They never sat me down to go over what a budget is. One day after I graduated from college and started making money and spending money, my father sat me down and asked where my money was going. I said, ‘Hey, Dad. Did you earn this money? No. Then don’t ask me.’ ”

Al probably would have been better off if he’d had that conversation with his father no matter how uncomfortable it made him. As it was, it took him a good decade to figure out precisely where his money was going — and that sabotaged his ability to save as much as possible for everything from college to retirement.

Al and his wife, Jean, have been married for 20 years. At the beginning of their life together, he went to work, and she handled the at-home budgeting — a very traditional division of labor. But over the years, Al realized that although he knew how much he was bringing home in each paycheck (and roughly how much Jean was taking in from her part-time job), he had very little idea where they were spending all that.

That was just the beginning of their downward spiral. Although neither Al nor his wife were raised with credit cards, both developed an affinity for charging. They convinced themselves they were spending money on things they needed. Al would walk into a department store and blow $1,400 on four suits he needed for work. Together, they wouldn’t think twice about charging a $150 dinner on a weekend, then spending another $30 at the movies.

They lived this sort of free-spending life for years. Then one day they realized that the balances on their combined cards had hit $20,000. They had no money in the bank and no retirement savings to speak of. Jean panicked. “She was worrying continuously for about six months,” Al said. He took a step back and decided panicking wasn’t going to do them any good.

“I said, ‘This is crazy. We just have to stop charging. We need to put the cards away and be disciplined.’” The next week he picked up a copy of Quicken, the popular personal finance software. Quicken — though it does many other more sophisticated tasks as well —  is, at its core, an electronic check register. You input how much you spend on which specific items; it deducts the expenditures from your overall balance.

Whenever you’d like to know how much you’re spending category by category, you can simply push a button and see your spending habits in pie-chart form. Al was amazed. “When you’re just looking at the individual numbers, the individual expenses, you really have no idea what you’re spending your money on. I was amazed at how much we spent on groceries, how much we spent on our cars. When you’re just looking at your balance, you’re not thinking ahead about where you want your money to go.” But that’s what Quicken forced him to do. It forced him to start choosing where his money might do him the most good.

And over the past few years, making those choices has enabled Al and Jean to dig their way out of debt. They stopped eating out as frequently, stopped spending money on cars and clothes. It took two and a half years for them to clear the $20,000 in credit card debt. But they didn’t stop there. They started overpaying on their car loan, tacking on another $150 to the $350 they owed each month. The result: They shaved a year and a half off the term of the loan. They’re overpaying on their mortgage as well, aiming to have the house paid in full in the next five years. The credit cards in their lives have been replaced by debit cards — although they have continued to hold off on big expenses. (Al would like a new car to replace his second one, a nine-year-old Honda, but he says, “I  just don’t want to cut the check for a new car. I want to write a check to the mutual fund for that amount.”)

And they’re saving. “We still don’t have a full three months’ emergency savings,” Al acknowledges. “But we have something.” Al sums it up: “By the time I’m 50, I want to know that my house is paid off. I want to know I have money in the bank. I don’t want the stress of owing money to other people. I want my balance sheet to be absolutely clean.”

Excerpted from the upcoming book "Pay It Down" by Jean Sherman Chatzky. Copyright © 2004 by Jean Sherman Chatzky. Published by Penguin Books, Inc. All rights reserved. No part of this excerpt can be used without permission of the publisher.