Ask John: Buried in Credit Card DebtBackgroundMeet Ellis, a 37-year-old father of 3 who lives in Denver, Colorado with his wife Rebecca. Ellis and Becky are both lawyers working for large corporations. Their household income is over $400,000 each year. They drive expensive cars, eat at expensive restaurants, live in an expensive house and send their children to expensive private schools. On the surface, they are living a great lifestyle filled with great vacations and lots of “stuff.” They’ve got it made in the shade…or do they? Ellis’s DilemmaIn addition to their impressive collection of expensive assets, they also have a less impressive collection of credit card debt, $52,000 of credit card debt to be exact. Ellis lives by the motto, “If I am paying my bills on time then my credit is good.” Unfortunately, this couldn’t be further from the truth. Paying your bills on time is very important if you want a good credit score, but it only makes up 35% of the points in your score. The other 65% of the points have nothing to do with whether you are making your payments on time or not. In fact, your level of debt makes up a surprising 30% of the points in your credit score. That makes “debt” a close second to “payment history” as far as their impact on your score. About a month ago, Ellis and Becky found out the hard way how important debt is to their scores. They went to refinance their $875,000 home loan to take advantage of lower mortgage interest rates. But, when their loan officer pulled their credit reports, their scores were less than 700. The score range is 300-850 and the median score is around 725. So, while Ellis and Becky have a household income that is in the top 5% of all U.S. households, a staggering 70% of all consumers have credit scores higher than theirs. How much did this cost them? They were unable to refinance their house, so they are still paying an interest rate of 6.75% versus a 5.75% interest rate. That 1% will cost them $570 each month, $6840 each year, or $205,000 over the life of their mortgage loan. All of this because they thought that paying their bills on time was the key to having good credit. When I explained this to Ellis, he was understandably upset. For years he has worked hard to earn a solid living but missed the mark when it came to good credit. What I had to explain to Ellis was the difference between credit worthiness and capacity. Credit Worthiness versus CapacityWhat Ellis simply could not understand was how someone like him, a lawyer making a six-figure income, couldn’t have great credit. He could easily take on more debt because he could easily generate the income to pay the bills. What Ellis’s finally came to learn from our conversation is that YOUR INCOME DOESN’T MATTER when it comes to your credit reports or your credit scores. Ellis was all wrapped up in the “I make so much money” mindset, but what he failed to realize was…
Ellis’s Options and Best Course of ActionIn this case Ellis has very few options on how to address his problem. Here’s the best course of action:
So Who’s at Fault?There are two parties who need to share the blame here.
And, don’t expect any friendly disclosure explaining that the higher your balances the lower your credit scores. SummaryThe lesson that Ellis learned was that a good credit report isn’t necessarily a credit report that is void of delinquencies. It takes solid performance from a number of categories, one being your level of debt, to achieve a great rating. Hopefully, he can reign in his family’s unchecked use of his credit cards and get his balances down to a more respectable level. Go for it Ellis. Best of luck!!
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