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Languishing in Loads of Liabilities

06/26/2015 08:07 am ET | Updated Jun 25, 2016
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Question:

Dear Steve,

After ending my domestic partnership I was single and on my own financially for just under three years. I have since re-married, but incurred approximately $30,000 in credit card debt, while I was the only income for my family of four.

I have $13.5K debt on a card with 12% APR. I have $16K debt on a card with 10% APR. My credit score dropped from 806 (three years ago) to 640 now. I also have $50K equity in my home, but don't want to re-finance because my original rate was 3.25% fixed APR, and I know I won't see that rate again if I re-finance my mortgage.

I inquired recently into a HELOC, but was told my credit score was too low and needed to be 680 minimum to apply. Since my spouse is an immigrant, and has only lived/worked in the U.S. a few months, her score is also around 650.

My mortgage advisor said I could boost my credit score by taking out a third credit card, one with 0% interest for 18 months, and transfer some of the balances of the first two cards to the new card, as long as I don't go over half the credit limit on the third card. My new third card has a $20,000 credit limit.

What's the best way to get the largest payoff in the next 18 months. I am paying approximately $1000 a month towards the cards. Should I transfer $9000 over from the first two cards and if so, what amount from each one? Should I make larger payments on the cards with the higher interest rate, or pay down the 0% card first? I want to get the most bang (payoff) for my buck.

Susan

Answer:

Dear Susan,

First off, thank you so much for reaching out to me for help and advice.

It seems to me that there is a bit of a scattered approach to things at the moment and I think with a little organization this can all be dealt with.

I completely understand the accumulation of debt during a domestic transition. Divorce often creates big financial hurdles for households now divided. What used to be adequate income for a partnership of two becomes inadequate for new homes of one spouse. It's exactly the reason why so many divorces are followed by bankruptcy of one of the spouses.

Quite frankly it is stupid easy to rebuild awesome credit if you apply some organization and time. You can see my guides on how to do this, here and here.

The basic building blocks or getting bad credit boosted is to stop whatever activity was bringing you down and then get back into playing the credit reporting game.

So many people don't understand credit scores. A credit score is not an indication of how well you manage your finances. It's an indication of how profitable and risky you will be to a creditor.

So to have a high credit score you need to keep that in mind. A creditor isn't looking for people who don't pay their bills on time. So pay them on time. They are not looking for people who are always maxed out. So don't max out your cards on a regular basis. They are not looking for people that can only get store or gas company credit cards. So don't get them.

Regarding the advice the mortgage person gave you, generally the rule is don't run the balances up more than 30 percent of the limit. But in your case I'm going to suggest you disregard that advice and one other rule.

I think what your situation needs is the application of math. In the long run the ability to knock out the debt fast is going to serve you well and boost your score.

I would suggest you move as much as $18,000 of the highest interest rate credit card debt onto the new card as you can. Max that new card out with the transfers and hopefully there are no transfer fees. I know, sounds crazy, right?

But if you do this and pay $1,000 a month towards that card you will payoff $18,000 of debt in 18 months, for free! Why not use the banks money to your advantage for once?

That leaves you with a minimum payment on the 10% card balance. Make whatever that is this month and don't reduce it as you go. Once the big debt is paid off, focus your efforts on the balance left on the 10% card.

Now, some people might say the 12% APR debt is now 0% so focus your efforts on the 10% debt, which is the highest now. But the goal is to eliminate the 12% APR debt using the banks money and not let it sit on that new card and get stuck at a future, potentially more expensive, interest rate. That's where people screwup when doing balance transfers. They let their debt go on holiday on the 0% card and then it gets stuck at a high future balance. That's the whole goal of the balance transfer offer by creditors. To stuck you in and trap you.

While you execute this plan keep in mind you should not increase your balances, your good on-time payment history will help your credit score and so will your decreasing debt balance. Make sure you do not close that expensive card you transferred the balance from and you will watch your score grow and grow as you watch that balances get smaller and smaller at 0% APR.

If you'd like to monitor your credit score progress along the way, one free service I like is the free credit score monitoring by Credit Karma. I use the service myself.

It seems that if you follow this strategy, you won't need a home equity loan and it will lead to improving your credit score in the next 18 months.

Steve

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