08
May

credit repair

Anyone can create wealth and get a great credit score, even on a low income.

It’s pretty easy for financial experts to tell you to lower your debt to improve your credit score. However, it’s not that easy to do. Once you’re caught in a cycle of debt, the easy part is watching most of your payments go to fees and interest each month, so that you make pitiful headway against your balances and you’re left with the feeling that you’ll never get ahead.

How is debt related to credit score?

You’ve got to lower your debt if you want to improve your credit, and you’ve got to improve your credit if you want better terms like zero percent offers or a low rate on a mortgage.

A very large part of your credit score – 30% of it, in fact – is based on your utilization ratio. That’s the amount of debt you have relative to your credit limits. To figure out your utilization, add up all of your debt and add up all of your credit limits. Divide your total debt by your total credit limit, and that’s your ratio.

Utilization has nothing to do with how much you owe, but only with how that number compares with the amount of credit you have. The same amount of debt means very different things for consumers who have different credit limits.

If you’ve got a $950 balance on a credit card with a $1,000 limit, your utilization ratio is 95% and that’s very bad. You can’t achieve an excellent credit score with a utilization ratio that high even if you do everything else right. But if the same $950 balance is spread across three cards that each have a $1,000 credit limit, your utilization ratio is just 32% and now you’re on solid footing for a good (or great) credit score.

There is no magic number for “good” utilization. In fact, the closer it is to zero, the better the effect on your score. You do not need to have debt to have great credit. People with credit scores over 800 tend to use no more than about 7% of their credit. Even if you have multiple credit cards, don’t max out any one of them.

How to find money to pay down debt

Interest charges eat up huge proportions of each payment, so no matter how diligently you pay the bill, it can feel like you’ll never reach zero. The key to paying off debt is to make larger payments and knock down the principal balance as much as possible each month.

There are two ways to find money to make larger payments. (1) Spend less on other things. (2) Earn extra money.

Not everyone has the opportunity or time to pick up another job for extra income. But most of us spend money that could be used to pay down debt. No matter how tight your budget, you’ve probably got some wiggle room.

The way to find money (in your current budget) to pay down debt is to completely reset your spending habits.

Go on a financial fast

A financial fast is like a food fast. You go without for a set period of time.

In a financial fast, you’ll spend on nothing but essentials for three weeks. Here’s the challenge:

  • Pay the rent and other household bills to which you are already obligated
  • Pay for your subway pass or other transportation to get to work
  • No discretionary spending whatsoever. No restaurant meals. No clothing. Postpone any trips to the hairdresser or nail salon. No gifts for others.
  • No discretionary spending on your kids. They also need to learn that mom or dad can’t buy them whatever they want whenever they want it. They can wait three weeks.
  • Use cash only; no debit or credit cards. Why? Because countless studies show that we spend less when we use cash. Also, you’ll rekindle your relationship with every dollar you earn.
  • Don’t let anyone else pay for you or visit stores just to browse. One of the goals of the fast is to stop using spending and buying as a form of entertainment or therapy, and that includes OPM (other peoples’ money) or choosing things now that you want to go back and purchase later.
  • Do the fast during a three-week period when you don’t plan to travel and you don’t need to do birthday or holiday shopping. Don’t give yourself an excuse to break the fast before you even begin.

This may sound extreme and it is. You will probably feel uncomfortable or frustrated at some point during the fast. It’s the first step to financial freedom.

Each time you spend a dollar, you make a choice. We choose to pay the rent and utility bills because the consequences for failing to do so are harsh. We choose to buy groceries or eat out at restaurants. We choose to buy a new item of clothing when we see a great sale. No matter what it is, whenever we spend (or don’t spend) money, we make a conscious choice.

Do you know where every dollar went last month? A financial fast helps you put a laser focus on your spending habits so that you can learn to make money choices that align with your priorities and goals.

When you learn to make better conscious choices with every dollar in your pocket or bank account you can start making progress. Even if you find just $20 extra this month to apply toward debt, that’s $20 that will go to the principal balance and lower the cost of your debt over time. Many fasters find much more than $20 extra.

Michelle Singletary, personal finance columnist for the Washington Post, wrote a fantastic book about the 21-day financial fast, designed to be read one chapter at a time each day during the fast.

This three-week challenge could make you a better money manager and help you stop adding to your debt load.

Are you willing to give it a try?
If you’re looking to repair your credit to raise your credit score click here. You can also carry on the conversation on our social media platforms. Like and follow us on Facebook and leave us a tweet on Twitter.