If you've been following our videos, we've been covering strategies to not only understand how your credit score is calculated, but also how to build a plan of action to improve those scores. Today we’re going to end by covering a couple common strategies used for credit building and debt elimination. I will tell you in advance: everything in today's blog is my opinion on techniques you've probably heard thrown around in the past like credit card surfing and debt snowballs.. I always want to separate absolute fact from my views on topics, and I definitely want you to know the following is my take on these strategies, and you may feel differently based on your situation. So let’s get started:
Many of you are familiar with the concept of a debt snowball. For those of you who aren’t, essentially you take all of your bills and in addition to making minimum payments, you add as much extra as you can towards the smallest bill. Once that bill is paid off, you then take that amount each month and add it onto the next smallest bill, and so on and so forth until all your debts are gone. This is a great strategy for paying off your debts, but there are two ways to start:
1. Lowest debt>>>>>>>>>>>>>Highest debt
The first way is what we just described, attacking the bills from the smallest to largest debts. Part of what makes this so powerful is by attacking the smallest debt, the hope is that you pay it off quickly, and the rush you get from paying off that debt will motivate you to keep going. If you know yourself and feel you need that motivation, by all means do it this way. There is another way, however, that depending on your bills could not only mean paying them off faster, but also helping your credit score faster.
2. Highest interest>>>>>>>>Lowest interest
The one problem with paying off your bills from largest to smallest balance is that method doesn’t take into consideration the interest rates for each debt. If you have an account with the highest interest rate and it’s also the highest balance, the traditional debt snowball would mean you wait to pay this bill aggressively until the end of the snowball. Because it’s the highest interest rate, this would mean that balance is not only the easiest one to lose control of, but also that it will take longer to pay down your debts until you’re within the 30% threshold we talked about in Part 1 (link to that video here). So, if you’re doing your debt snowball with your credit score in mind, paying off your debts from the highest to the lowest interest rate, instead of the lowest to the highest balance, could help speed up not only your debt elimination, but also the process of getting your debt in good standing when it comes to your FICO score.
I’ll say this: in my opinion, there are many instances where using a credit card responsibly can be beneficial to your finances. The problem is, we need to build a really strong foundation before I start giving you advice on how to do that. So until we get further into our video series when it comes to things like budgeting and cash flow, I’m going to stick to two basic rules here: Number 1.) if you aren’t to the point where you are only spending money on a credit card that you have in the bank and can pay it off IN FULL before the end of the month, you need to avoid using a credit card for anything other than emergencies. People who use credit cards wisely do not carry a balance on their credit cards; they pay them off in full before any interest accumulates. Number 2.) if you have never had a credit card and need one for emergencies or for work charges, or you’ve been burned by cards in the past and need one with more safeguards, consider a secured credit card.
What is a Secured Credit Card?
There are two types of debt: unsecured, and secured debt. Unsecured debt is basically debt you have access to without having to give any collateral. Meaning, if you don’t pay your bills, you didn’t give them anything of yours to keep. Credit cards are an example of unsecured debt. Giving you a credit card is a huge risk for a credit card company because if you don’t pay them, they can’t really come take anything from you to recoup their losses. Because of this, they charge you a higher interest rate to take on the risk you might not pay. Secured debt is different; with secured debt, you have to give up collateral, and because you can lose something in the event you don’t pay, interest rates on this type of debt is typically lower. A car loan is an example of secured debt. You get a car loan, and you have set payments at a set interest rate. If you don’t make those payments, eventually they will come take your car. A secured credit card is very similar. To get a secured credit card, you have to make a cash deposit, this is your collateral. Based off of how much you deposit and also what your credit score is, a company will give you a certain credit limit. So for example, if you have good credit and make a $500 deposit, a company or bank may give you a credit card with a $500 limit. If you have poor credit or haven’t established credit, you may make this same deposit and be offered a lower limit, say $300. Because you made the deposit and gave them collateral, the interest rate on a secured card is typically lower than on an unsecured card. And, while the exact terms differ for different carriers, if you ever want to get out of the card, a portion or in some cases all of your deposit would be returned to you. Please please remember that this card isn’t to establish debt. It’s to establish good payment history and responsible use so it can benefit your FICO score.
Credit Card Surfing
If you’re not familiar with credit card surfing, the idea behind it is this: oftentimes credit card companies will give you an introductory offer where they offer you 0% interest for a number of months. People with debts on other cards will transfer that debt to the new card, use that introductory period to pay down their debts as much as they can, and when the time period ends, they then transfer that debt to another card with 0% interest, and so on and so forth until the debt is gone. While I can’t say that I haven’t seen this work, I would ask you how diligent you plan to be with this strategy. For one, it requires you to actually use that time to knock down the debt as diligently as you possibly can, which may not be something you’re ready to do yet. Secondly, in terms of organizational skills, managing credit card surfing can be really tough, because you may not be the type to manage your calendar and keep track of when it’s time to switch cards. Third, finding a card that will both approve you and allow you to transfer your debt to it is no guarantee, which means you may have to apply multiple places that will check your credit. And if you remember in Part 1, not only does having your credit checked too frequently hurt your score, but opening new accounts also hurts the part of your score that rewards you the older the average age of your accounts. So since credit card surfing is likely to really damage your score at the beginning and only helps if you diligently pay off the debt, it’s not something I would recommend to your average person at all.
If you have high amounts of debt and a decent credit score, there is something that in my opinion is worth looking into: a personal loan. Banks and credit unions will often offer personal loans to their customers and allow them to transfer credit card debts into the new loan. If your credit score is decent but the interest rates on your debts are too high for you to make a dent, talking to your bank or credit union about whether or not you’d qualify for a personal loan could potentially give you relief not only on the interest rate you’re paying, but also help you pay off your debts faster.
That’s it! We’re done with credit for now. In our next video series we’re going to cover something that’s a crisis in our country right now: student loan debt. We’ll talk about payment plans, student loans for married couples and more, so I hope you tune in to my Youtube channel to check that out. As always, if you have a topic you'd like for me to cover on the blog, please fill out our questionnaire and let us know what would be helpful for you!