Beating Broke

Personal Finance from the Broke Perspective

Being Debt Responsible

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What does being “debt responsible” mean, and how do you do it?

Being debt responsible means taking responsibility for your debt and it’s payoff without making excuses or trying to find easy ways out through debt write-off, negotiation with creditors, or bankruptcy.  In a nutshell, if you signed on the dotted line, you must pay it off.

Why must you be debt responsible?  The most commonly referenced reason that you must be debt responsible is that, by signing the note, you were guaranteeing that the debt would be paid.  You also accepted the conditions of repayment.  Some of those conditions, such as interest rate, are somewhat negotiable even after you sign the note, but not the amount of the actual debt.  The most important reason for being debt responsible (to me at least), is the moral requirement.  Morally, whether you look at it religiously or secularly, you have a responsibility to repay the debt.   Again, it goes back to your acceptance of the debt and it’s conditions.  Morally, you have a responsibility to uphold your part of the bargain.

Luckily, for most of us, it’s extremely easy to be debt responsible.  We just have to pay our bills each month.  But what happens when an emergency strikes and you can no longer pay your bills?  That depends.  Can you really not pay your bills, or can you not pay your bills because you have to go out to Red Lobster next Thursday?  If you really, truly cannot pay your bills, you have what is one of the only exceptions to any of the above rules.  You are free to negotiate as much as possible to reduce your payments, delay your payments, and even reduce or eliminate your interest payments.  Only in the most extreme cases should you try and reduce the debt or eliminate the debt.

Being debt responsible isn’t always fun.  (Who am I trying to kid?  It’s never fun.)  But, it’s the right thing to do, not just morally, but for your personal finance as well.

Unused Credit Cards are Being Closed

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According to J.D. and several other places I’ve seen, Credit Card Companies are Being a lot more pro-active about closing unused Credit Card Accounts.  Why would they do that?  And why does it matter to you?

First, they do it because every open account costs them something.  It may not be much, but they still have to process the data and maybe even send out a statement.  Many have moved to not sending out statements on accounts that haven’t been used, but some still do.  Most importantly, any open account is an open credit line.  It’s a potential liability for the credit card company.  If you go from having no balance to maxing out a 5000 card, you’ve just added $5000 in liability to the company’s bottom line.  Not to mention that doing so is a likely red flag for impending financial trouble and that makes the liability a risky liability.  Any way you look at it, that isn’t good for the company.

Of course, if you continue to not use the card, it really doesn’t cost them much.  It’s just the potential that they are not willing to risk.  It’s a sign of increasing risk aversion on the part of the credit card companies.

So, why does all this matter to you?  Part of your credit score is based on your credit history.  The longer you have had an open account, the better it looks on your credit report.  It’s a sign of good credit management.  Another part of your credit score is the ratio of available credit to credit used.  So, if you have a $5000 credit line, and have only used $2500 of it, it looks better than if you had a $2500 credit line and had used $2000 of it.  If you have a credit card that you aren’t using, it’s adding to that unused portion of your available credit.  That’s good for your credit score.  But if the credit card gets closed, you don’t have that unused credit available anymore and your ration goes down.  And so does your credit score.

In both cases, the dip in your credit score is likely to be fairly small.  And it is likely not a huge problem.  But it is something you should be aware of if you had been planning on applying for any type of loan and have had a dormant credit card closed recently.  Also, if you are holding a card that you haven’t used recently and doesn’t have a balance, and want to keep it from closing, you can make a purchase with it once every couple of months to keep it active.  Just make sure to pay it off right away.

Want a Better Credit Score? Pay on Time.

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The number one, single most effective way to getting a better credit score is to pay your bills on time.  Followed closely by not missing any payments.  But if you’re following the first rule, you shouldn’t have any problems with the second rule, and you should be on your way to improving your credit score.

To begin with, you should know what range your credit score resides.  Lenders decide what rate you will get by your score.  Ever heard the term “A+ Paper”?  It’s not just a school essay grade.  Lenders use the term to indicate a loan that was lent to someone with a credit score in the highest rank range.  Typically, this is about a 730 or higher.

Before you go into despair, that is very attainable.  And it could save you hundreds if not thousands on your next loan.  But you’ve got to get there first.  So, go get your credit score.  Visit the annualcreditreport.com site and get your credit report from one bureau.  I say only one, because it works out fairly conveniently to get one from each of the three at about one per quarter.  Then you’ve got a running tally and they usually are pretty close.

In each case, you’ll probably have to pay a little extra to find out the actual credit score.  Be careful of the “trial offers” that are meant to trap you into a monthly fee.  If you have to sign up for one, make sure you remind yourself as often as possible that it needs to be cancelled before the monthly fee kicks in.

Now that you have your credit report and credit score, we can keep an eye on it to see how the changes you make will improve it.

Start paying everything early.  That means that if the bill is due on the 15th, you send it so that it’s there no later than the 12th.  In no way do we want the USPS to screw this up for us.  There can be forgotten holidays, weather delays, and even union strike delays, so we want to make sure that we can have a 2-3 day delay and still make it on time.  It’s the on time that is important.

So, why paying on time?  It accounts for nearly 40% of your credit score.  If you’ve been paying bills late, changing to paying them on time could increase your credit score by as much as 20%.  It’ll take a few months up to a few years to really kick in, but you should see a few points increase within a month or two.  And you can probably expect double digit increases if you’ve been regularly late.  It’ll just take some time for the on time payments to override the late ones.