Stepping Stone Wealth
Key To Wealth-Building: Approaching Your Credit Rationally
The primary purpose of good credit is to save you money by helping you procure lower interest rates that otherwise wouldn’t be available to you. Interestingly, some consumers fail to recognize this fact when considering the appropriate option for debt resolution. The main reason for this is a lot of people interpret their credit on an emotional level instead of a rational one. That is, they think of their credit score as something more than it is---something more than just ONE tool that lenders look at to determine whether giving you a loan will be profitable for them---and it becomes a matter of pride, not a matter of financial health. In the end, the mistake of thinking about one’s credit on an emotional level instead of a rational one can cost a consumer buried in credit card debt and only able to afford minimum payments thousands of dollars in finance charges and even more in the years of life consumed by financial anxiety. Another part of the problem is that most people, even when trying to tackle the issue rationally, do not understand what makes up their credit score.
The largest components of your credit score---your credit history and the amount you owe---are both influenced by debt settlement, one negatively (credit history) and one positively (the amount you owe). Although your credit history is marginally more important than the amount you owe when factoring your score, the difference (5%) is rarely enough to compensate for the savings from enrolling credit card debt into a settlement program. The more money you’re able to save from enrolling in a debt settlement program, the less the credit impact should be considered a factor. Why? Because any higher interest rates that you’ll end up paying down the road as a result of the credit impact will rarely outweigh the money you saved by settling credit card debt. So who in the end benefits the most from a settlement program----1) people who owe a lot; 2) people who can only afford to pay the minimums; 3) people who are paying high interest; and 4) all of the above.
To illustrate this point, consider the following examples. Let’s assume that you owe $30,000 in credit card debt. Your average annual percentage rate on these cards is 19 percent, and you are only able to afford the minimum monthly payment, which in your case adds up to $750 total. Given this scenario, it would take you approximately 12 years and $108,000 before finally you dug out of debt. In a debt settlement program, however, it would take approximately 3 years and $16,500 total to eliminate your debt. That’s a $91,500 difference versus making the minimum payments. Rarely will your subsequent higher interest rates ever make up the savings from debt settlement, especially when you consider the fact that you can always refinance any loans once you’ve built up enough equity. One of the most frustrating things to come across in our industry is a consumer who owes a lot and is only able to afford the minimums, but was still unwilling to sacrifice their credit even in the slightest bit in order to climb out of debt and save money. I recently dealt with a consumer from the South Side of Chicago who was $40,000 in the hole with credit cards. His interest rates were at 29 percent and he was only able to afford the minimum payments, which amounted to $1700 total in his case.
When he tried to convince the creditors to lower the rates, they simply told him that based on the amount of outstanding debt on his credit report he was too much a credit risk, so they needed to charge him higher interest. When he tried to obtain a home equity loan, he was turned down for the same reason, even though his credit score was in the high 600s. Yet when I mentioned that our debt settlement program might impact his credit negatively, he scoffed. There was no way he would ever affect his credit negatively. At the end of our conversation, I tried to referring him to our affiliate credit counseling company, but he wasn’t interested because enrollment in a debt management plan would appear on his credit. His decision to stay on course with the minimum payments will ultimately cost him over $20,000 a year and probably his young children the opportunity to attend a 4 year college, maybe more. By failing to be realistic and rational in his approach to the impact of debt settlement on his credit, this consumer worsened his financial situation significantly. He thought of his credit score not as something that can save him money by getting him lower interest rates on loans, but rather as some sort of social marker on where he was at in life. He considered the idea of a negatively affected credit score probably much like someone in the Middle Ages thought about the idea of being excommunicated or the way a 14 year old feels about not being part of the “in crowd” at school. When considering your debt resolution options, I urge you to look at the options available to you realistically.
When comparing debt settlement to the other options available to most consumers I find myself famous Winston Churchill quote on democracy: Debt settlement is the worst form of debt resolution, except for all the rest of them.
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