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.
Reminders About Credit Scores
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.
The Vasquezes' Mortgage Situation
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.
So, what Gil and Tracy want to do over the next few years is reduce their overall debt, while keeping up on all of their payments. If at all possible, they also want to chip away as much as they can on their 2nd home loan which carries a high interest rate.
What resources are available to people who are struggling to make their mortgage payment after their loan has adjusted? Or to people like the Vasquez family who are anticipating such problems in the not so distant future?
Families like the Vasquezes should not feel they are alone. As a result of the sub-prime crisis, many non-profits have formed with the purpose of helping homeowners understand their options before they get behind on payments as well as after.
Most recently, the HOPE NOW Alliance was launched to assist homeowners before their mortgage situation becomes overwhelming. HOPE NOW offers mortgage counseling services at 1-888-995-HOPE.
Another terrific resource is the National Foundation for Credit Counseling, which is the nation's largest and longest serving non-profit credit counseling organization. The NFCC sponsors a web site, www.housinghelpnow.org, which provides information and access to HUD-approved counselors who can help you sort through your situation, looking at your overall financial picture as well as the terms of your mortgage to determine an appropriate course of action. Counseling services are available at little or no cost, depending on your circumstances, and can be of tremendous assistance.
With an aggressive debt reduction plan in place and Christmas right around the corner, what is a realistic approach to holiday spending for the Vasquez family?
My best advice here is to commit to a cash only spending policy and to limit gifts to a few fun, yet inexpensive items. While the general rule of thumb is to spend three days of net pay, this strategy does not make sense if you are struggling to make ends meet.
Every family really needs to look at their individual situation and determine how much extra money they have to spend. Ideally, you do not want to wrack up credit card debt that you cannot repay the next month.
The Tax Man Cometh
Is there anything the Vasquez family should be thinking about as we enter tax season?
Gil and Tracy are anticipating a refund next spring, and while everyone gets excited about a refund, it generally means that your withholding is not correct. Essentially, if you are getting a refund, it means that too much is being withheld for taxes from each paycheck.
So, rather than being able to put that extra money towards debt reduction, you are loaning money to the government over the course of the year—and earning no interest, I might add—and getting it back the following spring.
My recommendation, be sure to re-look at your withholding each year and account for any changes in your life—like getting married or having children—which could impact your tax withholding status.