Dear Talking Cents Guy: I have a number of credit cards with debt on each of them. I cannot afford to pay the minimum payments but still want to pay something. Should I first cancel the cards? I have been not using them for about a month to try to curb spending. We have cut down or out of a lot of things that cost money. What is the best thing for me to do next?
–Drowning in Debt
Dear Drowning in Debt: That’s a great question. Without having details of how much credit card debt you have, or how many cards, here’s the best advice I can give. This may surprise you, but closing out credit cards can actually lower your FICO score. That’s right – it can lower your FICO score. You’d think it would raise your FICO score, because you are closing out accounts, so theoretically you would not be able to use them. But this is not the case.
A big part of calculating one’s FICO score is called “available credit.” Let’s assume you have five credit cards and each has a $2,000 credit limit. This means you have $10,000 in total credit limits. Let’s also assume that you owe a total of $6,000 over those five credit cards. That means you have used 60 percent of your “available credit”.
If you closed one of those credit cards, your “total” credit limit would now be $8,000 and calculating the percentage assuming that you still owe $6,000, you have now used 75 percent of your “total” credit limits, which, in the eyes of FICO, is worse than 60 percent. Ideally, you want to keep your used credit at about 30 percent — less than 50 percent is considered a healthy amount. Here’s a video explaining the calculations.
When I was going through my debt problems (I owed over $17,000 in credit cards), I tried to cut back on expenses as best I could. I was also trying to figure out where I wanted to be fiscally in a year, or in five years. I tried to call some of my creditors to see if they could reduce my interest rates, but had no luck.
A friend recommended that I call a nonprofit debt counseling company. The counselor walked me through my spending and budget, asking me a series of questions about my expenses and debt. It really got me thinking about where and how I was spending my money, and how to get my family involved in the budgeting process. She asked me questions about my goals, both short and long term.
At the end of the call, she reviewed a series of options for me that addressed both my expenses and debt. She gave me the information I needed to make the best decision for me and my family. The best part – this counseling was entirely free of charge.
For me, the most ideal option was to enroll in a debt management program. Because I was in the program, many of the creditors lowered my interest rates and lowered my payments. I was able to pay them all off within five years, and I am now blissfully debt free.
A debt management program may not be the best option for you, but you can’t go wrong by just talking to them. Find a good nonprofit debt counseling company and get some free advice. Even if you don’t end up enrolling in the program, a counselor can at least lay out your best options and help you understand what you need.
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