Twas the season of spending with American’s splurging over $1100 on gifts this holiday season. Credit card interest rates average around 24% with some department store cards pushing 30%; making it very difficult for some to pay off the debt.

Lendingtree reports that 42% of those who charged holiday gifts regret adding to their debts.

If you’re feeling a bit of a financial hangover from the holidays, you can take some steps to help ease the headache of credit card debts.

The first step is to review your credit card accounts. Make a list which includes the credit limit, current balance and the interest rate…kind of like a naughty or nice list.

The next step may vary depending on if you’re planning on obtaining a mortgage anytime soon, for buying a home or refinancing, or if you have no plans on obtaining a mortgage. I suggest two different strategies because one route may help you pay off debt faster and/or feel more rewarding and the other route may help optimize your credit scores for obtaining a mortgage.

If you have plans on buying a home or getting a mortgage for a refinance, remodel, etc. then this is the route you may want to consider. I recommend that you review your accounts and determine the following:

1. Determine which accounts are over limit. Work on paying these accounts to under the credit limit. Your credit scores are hit when your balances exceed the limit – even if it’s just by $1.
2. Next, review your list and determine what 50% and 30% of your loan limits are for your credit cards. For example, if you have a credit card with a $4000 limit, 50% is $2000 and 30% is $1200. Your goal is to get your balances owed to under 50% and then to under 30% of the credit limit. Determine the differences between the balance owed and either 50% of the credit limit or (if you owe less than 50% of the credit line), 30% of the credit limit. Credit scoring rewards you for keeping your balances under 50% and then 30% of the credit line amount.
3. Once you have your list with the amount you need to pay to get to either under 50 or 30% of the credit line, focus on paying down the one the will take the least amount to get under the 30/50 amount. For example, if one credit card with a $4000 limit has a balance of $2100 ($100 over 50% of the limit) and another card with a $4000 limit has a balance of $1500 ($300 over 30% of the limit); focus on paying down the card with the $2100 balance to under $2000 and keep it under $2000 until you move to the next debt using the same method.
4. Do not close or pay off accounts in good standing as this may drop your credit score.

NOTE: This strategy may need to be modified when there is more than one borrower who will be on the mortgage as lenders use the lowest mid-score of all borrowers on the proposed mortgage. It may be necessary to focus on one borrower (with the lower score) over another. It is best practice to consult with your mortgage professional to help develop a plan best suited for your goals.

If you don’t plan on buying a home or getting a mortgage for any reason in the next 12 months, you may want to try the “snowball method”.

With this method, you focus on paying off the smallest balance first. Once that balance is paid off, you apply that payment (from the recently paid off card) towards the next smallest balance until it’s paid off… and so on and so on, until all debts are eliminated. If you have two (or more) accounts with similar balance, focus on the account with the highest interest rate and eliminate it first.

The idea of the snowball method is that it feels rewarding to see your progress eliminating your debts. I typically don’t recommend this strategy when you’re getting ready to buy a home as once you pay off a credit card and no longer use it, the current credit scoring modules treat that as a closed account and you will lose any benefits from having it factored as an established account with good payment history (which is really beneficial to your credit scores). As much as paying off your debts in a timely manner is a great thing to do financially, you are generally not rewarded for this with your credit score. 

If you are thinking of buying a home (or getting a mortgage for a refi), it’s important to reach out to a licensed mortgage professional as soon as possible so that you can start working on a plan together. This plan should involve reviewing your current credit as well as your income/employment and your funds for closing. There are so many options available and things that are “common sense” (like paying off and/or closing debt) may actually be detrimental to the home financing process.

The good news about credit scoring is that your scores are not permanent. They change constantly depending on your balances and how you use credit.

I am available to answer questions, help review your credit and with your preapproval for your mortgage – even if your plans are a year or two away. It’s always an honor to help people who read my blog. 😁