Over 25 percent of individuals report that their debt has increased within the past 12 months according to recent statistics compiled from sources like the Federal Reserve and consumer surveys.
Almost 15 percent of households carry a debt load that requires over 40 percent of their total income for payment.
When individuals are struggling with money and facing increasing amounts of debt, they may make rash decisions under stress that impact their credit score and future finances. Here are three tips for dealing with debt without taking a hit on your FICO score.
Choose One Account at a Time
Reducing debt when you have minimal or no extra income can be an overwhelming task. Unless you work to reduce debt, however, you may never have the income to deal with it quickly.
There is a way out of this cycle, although it takes time, patience and willpower. Here are a few steps to follow:
- Continue paying each bill before the due date to avoid negative reports on your credit history.
- Pay the minimum or just above the minimum on all but one account.
- Pool your funds and see how much extra you can pay on that one account without getting yourself in trouble financially. Even if you can pay an extra $30, you will be making a dent in your debt.
Start with the account that has the smallest balance to get some motivation. It will take less time to pay off and when you do, you will have extra money to pay other bills each month.
Concentrating on one account at a time makes the task less overwhelming and can lead to a snowball effect, allowing you to pay off each subsequent account faster.
*Editor’s Note* That is one way to pay down debt based on emotions. Another option is to pay off the highest interest rate debt first, rather than the smallest balance. This second method may appeal to more logical thinkers and results in less total interest paid. Different strokes for different folks. *End Editor’s Note*
To Cancel, or Not to Cancel?
Many people often wonder does canceling a credit card hurt credit? Well, the act of canceling a credit card account alone will not reduce your credit score. However, balances associated with the closed card could hurt credit due to the way FICO scores are calculated.
One reason is that your credit score depends in part on the ratio of outstanding debt to credit limits on revolving accounts. For example, if you have a card that has a limit of $1,000 and you keep a balance of around $100 on a regular basis, your credit score may be higher than if you ran a balance of $900.
When you close an account while you still have a balance, you skew the ratio. For example, if you have a balance of $1,200 and you close the account, you now have that high balance and a credit limit of zero for the closed account. If you want to stop using a card, cut it up and work to pay down the balance before you close the account.
The exception to this rule would be a low balance card with a high annual fee. If you only owe a couple hundred dollars but the annual fee is $50 or more, it might make sense to close the account and avoid the fee.
Avoid Numerous New Accounts
Some people use zero interest and no payment periods on new credit lines to play a shuffle game with their debt. This can involve constantly opening new accounts and transferring old balances. A number of new accounts may or may not impact your credit score, but it can keep you from receiving loans for things like vehicles and property in the near future.
Moving to a better lender is not a bad idea, just make sure you are not hopping accounts every few months.
Dealing with debt during financial struggles can be frustrating. However, it is important to take your time and work to resolve issues. The quick and easy fix is usually not the best answer and can even lead to a reduction in your credit score.
Are you struggling with debt? What questions do you have? Be sure to check out the Debt Movement.
*Editor’s Note* If you’re interested in finding out an approximation of your credit score for free check out my Credit Sesame review. It is a great tool that can help you understand your credit score! *End Editor’s Note*