Using the Money in Your Home to Get a Fresh Start on Your Credit
It’s probably obvious to you that there are a lot of different types of debt, but did you know that some are better than others?
We asked Ben Dodd at Freedom Credit Solutions to help us explain. Here’s what he had to say:
As we all know, credit cards are considered bad debt for a few reasons. First, the interest is different than a car loan which is simple interest, or a mortgage which is amortized. Credit card interest is compounding interest accrued daily but referred to as a monthly interest rate. Second, it’s an unsecured form of credit which is always the highest interest rate and highest cost to borrow. And not only do credit cards have the most fees at the highest rate, they also have the ability to change your interest rate at any time with just a notice.
And some cards are worse than others when it comes to how they affect credit scores. For instance, charge cards or consumer finance accounts (retail store cards) are considered the worst credit accounts, as are payday loans etc. Even having them on your credit with a balance will lower your scores regardless of the ratio of outstanding balance to credit limit.
Bank backed credit cards are better for your credit score because they are usually only given to people with better credit scores and because of that they usually come with better interest rates. Thus they score better. However they only score better if they are kept within the preferred balance to limit ratios, which is under 50 percent. Your score increases if kept under 30 percent and you’ll see even greater increases if you keep your ration kept under 12 percent. However, a card that shows no usage actually lowers your score because the scoring model can’t score something that isn’t being used.
For the huge number of Americans with bad credit scores and large credit card balances, it’s easy to become overwhelmed and simply ignore the problem. However, learning a few basics about how different factors affect your credit score can give you the insight necessary to get your finances under control.
The first thing to do is sit down and categorize your debt. How much is owed on each account, what is the interest rate, what is your payment plan, and when is it set to be paid off? Once you have this information laid out, you can see which debt is the most hurtful to your credit (such as high-interest credit cards that you never manage to pay in full) and which are neutral or even helpful (like a car loan that you’ve never been late on and has a low interest rate.)
If you find that you have a large amount of debt you’d categorize as “bad” and which is negatively affecting your credit score, then you’re in need of a new financial plan. You’re likely already aware that you’re living outside your means, and that changes to your spending will help keep you from accruing more debt. But how do you pay off your past debt in a way that will give you a fresh start on your credit?
A good place to start is by looking at assets, such as your home. If you have been consistently paying off your mortgage, you likely have a good amount of equity in your home. The good news is that you can use this equity to pay off “bad” debt by taking out a second mortgage or refinancing your home. Essentially, you are agreeing to make a second mortgage payment each month in return for getting a lump sum of money to pay off the debt that is weighing down your credit score.
Ultimately there are three potential advantages to using the equity in your home to address your credit woes:
#1 – You can bring all your credit into “current” status by taking one action.
#2 – You can consolidate all your payments into one, hopefully lower, payment.
#3 – You can wrap all your debt into something that has tax deductible and lower interest instead of paying high interest that isn’t deductible.
However, before taking this step there are some things you need to do. First, you need to make sure that you are committed to living within your means. Taking out a second mortgage to pay off debt won’t have any positive effect if you go right back out and rack up the credit card bills. Utilize any online debt calculators and schedules to lay out a plan that works for you.
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We’re here if you need to close on your dream home fast (we are, after all, the “home of the 8 Day Close”) and we can help you get the right mortgage for you even when your credit isn’t great. Call your local office, or fill out our easy on-line form, to get one of our licensed loan officers working on the right financing to get you into the home of your dreams!