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Financial Literacy - Credit scores
MONEY MAKEOVER
A bright future ahead
Systematically beat down card balances and put bills on auto pay to bump up credit score.
Credit scoring, demystified
The plan

This elimination of high-rate debt can save her about $250 a month in interest charges that eventually she can use to start her emergency fund. Normally, we would recommend that she set up an automatic monthly transfer into a savings account for an emergency fund, but in this case we believe that this should wait until the credit card debt is reduced.

Negotiate with creditors
While it might not be a pleasant experience, Angel needs to contact the creditor who put the unpaid medical bill on her credit report. She should explain the circumstances to them and ask for a method of resolving the problem. With this amount being under $500, it should not take long for a regular payment schedule to satisfy this claim.

When she is talking to them she should ask them if they will put a note in her credit file that the obligation is satisfied as soon as she pays it off. This should help improve her credit history. It is important to try to get this agreement while she is negotiating a payment schedule with them. It might be the only time she has any leverage. Repairing past debt issues and getting her bills paid on a regular schedule will go a long way toward an improved credit score and lower credit card rates.

The purchase of her first home can help improve her credit score if she stays on top of the payments. Angel should make sure that the Monthly PITI payment will be automatically deducted from her account and that all of the new payments for her home are made in a timely manner.

Used retirement savings for home, now fix it
The next step she needs to take immediately is to start replacing the retirement savings that she is dipping into to buy her house. Borrowing from an IRA to finance a home purchase is often the only source of funds available to many first-time buyers. However, those funds come at a high cost. Although Angel avoids the early-withdrawal penalty for a first-home purchase, she will need to pay the income taxes due on the money. She also loses the power of tax-deferred compounding when she takes that money from a qualified plan.

She should sign up for her new 401(k) plan at work as soon as she is eligible. At a minimum she should contribute 6 percent of her salary. Her company's generous dollar-for-dollar match on the first 6 percent makes this is a no-brainer.

A bright future
Angel is entering one of the most exciting times of her life. She is starting a new career, getting married and buying a home. By taking care of her credit problems now and creating a budget she can live on, Angel is taking the right steps toward getting her financial life in order. While many of the components necessary to fix her credit score are in her reach, the one she can't control is time. By working with creditors, reducing balances and keeping all payments current, Angel should see continual improvement in her score as time goes by.

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-- Posted: June 18, 2007
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