Don’t close your credit accounts!

I recently had someone tell me they were going to pay off a credit card and close the account. I told them not to, and here’s why…

Let’s say you have 5 credit cards and each of them has a credit limit of $2,000. Let’s then say that your balances are $500 on each card. The totals would be as follows: You would owe $2,500 (5 cards @ $500). The total amount you can owe on these cards is $10,000 (5 cards at $2,000 each). You have borrowed $2,500 of your available $10,000 – therefore you owe 25% of your limit.

If you paid off one of your credit cards ($500), then you would owe $2,000 of the $10,000 available and now you only owe 20% of your limit. Lowering your percentage this way helps to increase your credit score. The smaller the percentage you owe, the more “credit responsibility” you demonstrate.

If you took that paid off credit card and closed it, you would then increase the percentage of what you owe… You would still only owe $2,000, but your total available credit would only be $8,000. This would raise you back to owing 25% of your limit. When your percentage goes up, your credit score goes down.

So, as you pay off your debts, you should not close your accounts. (If you pay an annual fee or a non-activity fee, closing the account MAY be an option here – depending what your immediate & future goals are).

Keeping your credit score up is a game. You should know the rules to have a chance at winning! I figured if my friend didn’t understand this, you may not either. So here’s your free advice for the day!

HGTV's Solution to Debt

HGTV has a show called “Income Property” where the host teaches a family how to turn a portion of their home into rental property by renting out a room or a basement or something along those lines. I caught the show last week, and while I don’t know all the details of the family on the show, here’s what I do know…

Two adults own a home. They are planning to get married in the near future. All their primary income currently goes toward debt repayment. The husband (to be) is already working an extra job, just to pay the monthly expenses and other bills that they have.

So then the host shows them a plan to redo / finish their basement so that it would be a rentable apartment. He shows them 2 plans, which are virtually the same except one cost $6,000 and the other costs $12,000. The one that costs more is due to the cost of labor, so the couple can save $6,000 by doing most of the labor themselves.

Now I realize that the host is a designer and not a debt coach, but I was still baffled that anyone would suggest to this couple to go $12,000 (or even $6,000) further into debt to get $700 in rental income.

Then the longer I thought about it, the less baffled I was. Most Americans do the same thing… they will refinance the mortgage on their house to lower their payment. They transfer balances or borrow “free” money to lower payments. …and the reason this doesn’t work – the reason it doesn’t get you out of debt, is because it doesn’t address the problem. The reason you are in debt to the point that it hurts is because you haven’t been accountable to where your money is going. You don’t have a plan. You don’t understand how money works. If a deal sounds too good to be true, it probably is! There is no magic to getting out of debt. Creating more debt to create more income is not the answer.

It did not surprise me that the husband (to be) was very reluctant to choose the cheaper plan that required all the work. Unfortunately, that couple will be spending the “extra” $700 that they have created in no time, and they will be further away from financial freedom than ever before…