Paying Down Credit Card Debt

Ready to own your own home?

When you’re ready to qualify for a home mortgage loan, one thing that will be considered is your Debt-to-Income ratio (DTI). If credit card debt is a big chunk of what you owe, you need to start now to develop and carry out a strategy to pay down credit cards and improve your credit rating in the process.

Credit card debt can affect your credit score in multiple ways. Your payment history is the single largest factor, accounting for 35 percent of your credit score. The amounts owed and your debt-to available credit ratio account for 30 percent of your score. Your back-end ratio (the ratio of your prospective mortgage expenses plus your existing debt payments compared to your monthly income) usually should not exceed 36 percent. Your credit cards can also be a plus on your credit score. How long you’ve had credit accounts for 15 percent and your mix of credit accounts for 10 percent, so using credit cards responsibly can help. You don’t need to carry a balance to get the benefits of using a credit card, so there’s no reason not to pay in full each month.

Fortunately, you can eliminate credit card debt, if you have a plan and commit to following it. And you could improve your credit score in the process. This 5-Step “Snowball” Plan works for many people:

  1. Take an Inventory of Your Credit Cards.
    • Make a list of all your credit cards with a balance. Include the outstanding balance amount, interest rate and minimum payment. Your monthly statement contains all the details.
  2. Organize Your Credit Cards by Interest Rate
    • Put the card with the highest interest rate at the top, and the one with the lowest at the bottom.
  3. Add Up Your Minimum Monthly Payments
    • The goal is to pay more than the minimum every month. Rework your budget and see how much extra you can come up with each month in addition to the minimum. Every little bit helps.
  4. Start Your “Debt Snowball”
    • As your credit card payments come due, pay the minimum on each card, except for the one at the top of your list. Add any extra money you have in your budget to this monthly payment.
  5.  “Snowball” Your Payments
    • Each time you pay off a card, increase the payment on the next card on the list by that amount.  For example, if you were paying $250 a month on your top card and you zero out that balance, add that $250 to the minimum payment for the next card on your list. Just keep rolling the payments over until you get down to one card. Now all your prior payment money is going toward that card, until it is paid off, too!
    • This relatively simple process is effective because of the way minimum payments work. They are calculated as a percentage of your outstanding balance. As your card balance decreases, so does your minimum payment. It can take years to pay off even a small balance, if you only make the minimum payment each month.

Using the “snowball” system, your total monthly credit card payment remains constant, regardless of your balance. You’re exceeding the minimum payment on the top card, and by doing so more and more money is applied to your principal, making it possible to more quickly pay off that card and each card that rises to the top. Targeting the most costly card minimizes the total amount of interest you pay.

There are other ways to reduce your credit card debt, but be sure that using one or more of these methods actually helps you to lower your debt long-term.

  • Call your credit card company and ask for a lower interest rate (APR). If you have a good credit history, they are likely to do it, because they don’t want to lose customers like you. It doesn’t cost anything to try, and the worst they can do is say no.
  • Transfer your balance to another credit card with a lower interest rate. Shop around for long-term, low- or no-percent interest rate transfer opportunities, or look into transferring some of your debt onto a low-interest card that you already have. Be aware of any balance transfer fees, how long the lower rate will last, ballooning interest rates and how long you will be required to keep your balance with the company.
  • Consolidate your cards by taking out a loan and using the money to clear all your debts and have just one lower-interest payment. The catch is that many people who consolidate their debts start to use credit cards again and accumulate new credit card debt.
  • Use your tax refund to pay off at least some of your credit card debt and other debt.
  • See what you can sell to lower your debt. Think seriously about whether you really need these items, especially if you’re paying for them on installment. Liquidating big-ticket items, or even several small ones now can mean less financial hardship later. Use a sales method that will yield the highest resale value.
  • Make payments on time. If you skip a payment, you will be penalized and charged a higher interest rate. Your credit history will be negatively affected, which will lower your credit score.
  • Don’t spend more than the credit card’s limit. You may be charged for surpassing the limit, which adds to your debt.
  • Track your spending. People tend to spend more if they pay with plastic or pay for things using multiple accounts. They never see the net total until the bills come. Manually tracking expenses helps you make better decisions and identify areas where you don’t realize you’re overspending.
  • Reduce your expenses by spending less on entertainment. Borrow books from the library. Don’t buy your lunch at work. Pay cash for unnecessary purchases, or use the money to pay more on your existing credit card debt.
  • Build an emergency cash fund. Using credit cards for unplanned expenses can undo months of payments. Everyone needs to have some money set aside strictly for emergencies. When you resist spending money on something, set the money aside in a savings account or hide it somewhere in your house where you won’t see it. Don’t touch it unless it’s a real emergency.
  • Don’t relax your spending because you’ve successfully paid off some debt. When your credit card balance go down, you might be tempted to treat yourself. Don’t do it! A few purchases can put you right back where you started.

Improve your chance of approval on a mortgage loan by paying down your credit cards and paying them off in full if you use them again. Don’t make any large purchases right before applying for a loan, and be aware of other debts you have that may negatively affect your DTI.

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