Suze Orman: Tips to pay off credit cards

Suze Orman, financial expert and host of the award-winning “The Suze Orman Show” on CNBC, says that 2009 is a critical year for your money. There are safeguards to put in place, actions to take, costly mistakes to avoid, and even opportunities to be had so that you are protected during the bad times and prepared to prosper when things take a turn for the better. In this excerpt from her book “Suze Orman's 2009 Action Plan,” she answers questions about credit.

Chapter three: Credit

The new reality
The banking industry is running scared. They think you won’t be able to keep up with your credit card payments in 2009 as the nation continues to work its way through this economic meltdown. Of course, that’s a justifiable concern whenever the economy slows down, jobs are lost, and unemployment rises. But what’s different in 2009 is that banks are already reeling from the mortgage-default crisis that has triggered bank failures and shotgun marriages between weak banks and less-weak banks. Banks aren’t exactly in great shape these days and they are painfully aware of a Category 3 hurricane about to bear down on them: National credit card debt is at a staggering $970 billion, 50 % higher than when the last economic slowdown hit in 2000. That’s what happens in an era of “easy” money where banks irresponsibly hand out multiple credit cards to anyone with a pulse, regardless of income, and consumers are all too eager to play along.

The game, however, is up, my friends. Credit card companies have reversed course. They are now looking for ways to lend less money, espe­cially on accounts they deem risky: consumers with high unpaid balances and poor FICO credit scores. Reducing credit card limits, closing down accounts with no warning, and abruptly increas­ing interest rates are just some of the aggressive tactics the card companies are implementing right now to shore up their business. That means seri­ous repercussions for you throughout 2009. Your FICO score may drop — not because you changed your financial behavior, but because the credit card companies changed the rules on you.

The best way to insulate yourself is to get out of credit card debt once and for all. If you pay off your balance, you don’t have to worry about the interest rate on your card. If you pay off your bal­ance, you are less likely to have your credit card limit reduced; and even if it is reduced, it will not have a negative impact on your FICO score.

If you pay off your credit card balance, you can focus on building an emergency savings fund. That’s especially important in 2009. The days of using your credit card as a de facto emergency fund are over. If you tap too much of your credit card line, it is likely you will see the line reduced, your interest rate rise, and, yes, potentially have your card closed down — and there goes your FICO score. Unpaid balances in 2009 will put you in the middle of a vicious cycle. You must get out of card debt now. It is the number one action to take in 2009.

What you must do in 2009

• Make it a priority to pay off your credit card balances.
• Read every statement and all correspondence from your credit card company to make sure you are aware of any changes to your account, such as skyrocketing interest rates.
• Work to get your FICO credit score above 720.
• Be very careful where you turn to for help with credit card debt. Debt consolidators are often a very bad deal. The National Foundation for Credit Counseling is a smarter choice.
• Resist the temptation to use retirement savings or a home equity line of credit to pay off credit card debt.

Your 2009 action plan: credit
Situation: You always pay the minimum amount due on your credit card bill and are never late, but your credit card limit was just reduced.

Action: Paying the minimum in 2009 is not good enough. Credit card companies are antici­pating that as the recession plays out, consumers will be hard-pressed to keep up with their bills. So even if you have paid on time in the past, they are worried about what will happen in the future. And the fact that you pay just the minimum is a huge warning signal to your credit card company. It’s a tip-off that you may already be on shaky ground.

Paying just the monthly minimum due signifies to a credit card company that you may fall behind on payments in a severe recession and that you are also more likely to let your balance grow if you hit hard times. And that’s the last thing they want in 2009. To keep you from doing just that, they cut your credit limit.

Situation: You are worried that a lower credit limit will hurt your FICO credit score.

Action: Pay off your balance every month and your FICO credit score will not be affected. Your FICO credit score is based on a series of calcula­tions that measure how good a credit risk you are. One of the biggest factors in your credit score — accounting for about 30 % of your score — is how much debt you have. There are a few ways that this specific calculation is done, but one of the chief ways it’s determined is the debt-to-available ­credit ratio. Debt is how much money you owe on all your credit cards. Available credit is the sum of all the credit lines that have been extended to you. The higher your debt, the worse it is for your FICO score. And your debt-to-credit ratio will look much worse if your credit limit is cut.

Let’s say you have only one credit card that has a $2,000 balance on it. Last year your credit limit on that card was $10,000. So your debt-to-credit ratio was 20 % ($2,000 is 20 % of $10,000). Now you find out that your credit card company has reduced your credit line to $5,000. That means your ratio shoots up to 40 % ($2,000 is 40 % of $5,000). That will indeed have a negative impact on your FICO score.

The only way to keep your FICO score unaf­fected by a credit-limit reduction is to get out of credit card debt and pay off your bills in full each month.

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