Putting a stop to credit card use was a huge hurdle for the Vasquezes. Where do they stand now?
With 16 credit cards—nearly all maxed out when we met—the Vasquezes had to make some drastic moves to get their debt under control. As a follow-up to the first segment featuring Gil and Tracy, we received a lot of feedback about cancelling some of their cards and I wanted to clarify our efforts and goals in this area.
Gil and Tracy cancelled five of their 16 cards, and agreed to a spending freeze on the remaining 11 cards. While cancelling cards can result in a negative hit to your credit score, in extreme cases like that of the Vasquez family, the only way to stop the spending is to cancel some cards to eliminate even the possibility of wracking up more debt.
Keep in mind, not so long ago, Gil and Tracy borrowed approximately $15,000—at a very high interest rate—to pay off all of their credit card debt. And, at this point, they have built the debt back up due to some financial hardships.
Right now, what matters most is actively lowering their overall debt, which will lead to an improved credit score over time.
Remember, overhauling your finances and spending habits is a complicated and pain-staking process, and there are no easy fixes, but with commitment and diligence, things can get better.
What are the components and how can people improve their score?
Several factors contribute to credit scores, including the type of credit, new credit and the length of your credit history, but the two biggest components are bill paying history worth 35% of your score and credit utilization worth 30%. With bill paying, paying regularly and on time is critically important. In terms of credit utilization, a utilization ratio of 35% or less is good.
To give a simple example, if you have two credit cards and between the two cards, you have combined limits of $10,000, you want to keep your total balance under $3,500 (or 35% of $10,000). That said, although the components of a credit score are standard, you will find that your credit score will probably vary from credit bureau to credit bureau.
So, my advice is not to get too obsessed with the number and really focus your efforts on debt reduction and on time bill payment.
What do they need to focus on moving forward?
With an adjustable rate mortgage, the Vasquez family is in the same boat as many other American families—in fact, over the next four years, about $1.5 trillion in mortgages will reset. Like many homeowners who bought with the belief that their property value would only go up, Gil and Tracy have two home loans and very little, if any, equity in their home.
The interest rate on their primary loan is set to adjust in 2011, so their goal over the next few years is to do everything they can to make themselves more appealing to a lender for when they try to refinance.
Lenders want borrowers who can manage their debt well—meaning make timely payments and keep overall debt levels low—as well as those who are not living beyond their means. The higher your debt compared to your income, the riskier you become in a lender's eyes.