Profile: Angel Smith

The problem:
Low credit score limits mortgage-financing choices.

The plan:
Boost score with auto bill pay and by zapping card balances.

The plan in 6 steps:

1. Start a budget.

  • Track all spending, big and small.
  • Create a written budget of all expenses.

2. Attack credit card debt.

  • Set up automatic payments for each credit card to stop the late-payment fees.
  • Pay extra on the card charging the highest rate.
  • Systematically pay down credit cards

3. Deal with unpaid medical bill.

  • Contact original creditor and negotiate.
  • Get on a monthly payment plan to get rid of this debt.
  • Ask creditor to put a note in credit file.

4. Start an emergency savings account.

  • Once all credit cards are paid, start a savings account.
  • Put $250 per month in savings.

5. Work on improving credit score.

  • After mortgage is approved, set up an automatic payment through electronic bill pay
  • Be careful not to spend more than budgeted on expenses.

6. Get back on the retirement savings cycle.

  • Sign up for employer’s 401(k).

Keys to success

  • Create a process for tracking every dollar spent and made.
  • Consistently spend less than you make.
  • Use the debt pay down calculator to create a complete schedule to zap debt.
  • Go electronic and end late fees. Put all monthly payments on automatic bill pay.
  • Don’t hide from creditors. Call and negotiate payment options.
  • Start an emergency savings account.
  • Contribute to tax-deferred retirement accounts.

The plan

Get current on bills
Although credit repair is the ultimate goal for Angel, she needs to begin by getting her finances under control. The only way to do that is to create a budget. This will give her greater control over her undocumented spending habits. She will need to keep track of her spending and limit her impulse purchases on those high-interest credit cards. Once she knows where the money is going, she can attack the credit scores. The two largest factors in most credit scores are timeliness of payments and the amount of outstanding balances. Angel can take steps to improve both of these.

Angel has made a good start by setting up electronic bill payment through her bank. What she must do now is have an automatic payment made to each credit card account on a monthly basis. As long as this is a reasonable amount, and she can check by looking at past statements, she will cover the monthly minimum payment and reduce some of the outstanding balances. By setting up automatic payments she does not run the risk of missing payments again and will improve her scores. This strategy has the added benefit of taking the cash out of her account, which lowers the temptation to withdraw it from ATM machines.

Dealing with emergencies
While Angel feels she needs four cards to fall back on if she has a financial emergency, she would be well served to reduce her total level of debt. She should make extra payments to reduce the principal on the card with the highest interest rate first. Then she should work at them one at a time until the debt is reduced. Paying off the credit card debt will improve her debt-to-available-credit ratio, which will help her achieve better rates in the future. She should aim for outstanding balances of less than 25 percent of her credit limit.

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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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