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Credit Card Question From a Reader

By JLP | July 11, 2007

A reader named PRGal left this question in the comments section of another post:

I have a question for all you credit card wizbangs out there …

Recently, my husband and I received a very large sum of money and wish to pay off our two credit cards totaling $20K. The remaining funds will be carefully invested.

While we do have a 2 year old mortgage of $240K, we have no other debt. We own both of our cars, our student loans were paid off several years ago, and we have both been very aggressive with our retirement planning as well.

Our Chase card has a 3.99% rate until the balance of 11K is paid off, and our Citi card has a 8.99% rate on the 9K balance. To date, we’ve been paying $300-400 over the minimum every month on each card, but now, due to this recent blessing, wish to wipe it out in one big swoop.

Is there an optimal time in the cycle to pay off these balances in full, and if so, will doing this have any effect on our high FICOs? On one site, I read that you should pay off a balance in full over a period of a few months rather than in one lump sum?

Thanks for all of your great advice. We visit regularly.

My answer:

Pay off the credit cards now. Although I’m not positive on this, I don’t think it makes a difference whether you pay them off over time or do it with a lump sum. If you must, then pay off the Citi card first and string out the Chase card over time since it has a low interest rate.

If you do pay want to pay your cards off in full, be sure and call the credit card companies to see how much you need to write the check out for. Some cards will make you pay the interest up to the date of the final payment, which means you could still owe more money after you thought you paid the card off.

In any case, rejoice in the fact that you received a large sum of money. That’s great news!

A couple of readers left responses to PRGal’s question in the other post’s comments before I had a chance to post on this:

Brad from AnalyzingWealth said this:

PRGal: Pay it off all at once as soon as possible! It will only help your credit score, as your utilization (used credit divided by available credit) will decrease. There will be no credit benefit for paying it over time when you can knock it out right away. You will only lose money due to interest. What site did you read this on?

How fortunate for you to have this opportunity! There are many in this PF community trying to get rid of their debt . . . I bet they wish a large sum of money would come a long and help them out.

Long-time reader and commenter of AFM, Miguel, said this:

I somewhat agree with Brad - you should probably use some funds to pay off the CC.

The real question is what to do with your new found prosperity so that it serves you best in the long-run. I’m assuming you’d still have a decent amount leftover from the CC pay-off. I’ve been the fortunate recipient of windfalls from time to time (thru business & r.e. transactions, bonuses, stk options, etc.). And my income is very lumpy anyhow.

Here’s how I handle the windfalls:

1) Pause, take a deep breath, let the funds sit for a few weeks while you gather your thoughts. Commit to doing nothing for a little while to let the dust settle. Discuss the options at length with your significant other and/or trusted advisors. Don’t do anything until you have a clear picture of where your priorities are and how the money will best serve those priorities.

2) Establish or revisit an annual budget.

3) Pay off debt (except for mortgage). I think its important to live as debt-free as possible and establish a mindset of ALWAYS paying off the balance on CC’s each month. I do not pay down my mortgage because it is extremely cheap capital which allows me to maximize my higher yielding invmnts (a much debated topic here).

4) Ship the long-term money into accounts where it is not easily accessible. My fin’l planner acts as a guard dog. In order to get to my invmnt funds, I have to talk to her. That means, she is going to ask me why I want it. And that means having to explain to her how I want to do something stupid and materialistic with my money. The very thought of suffering thru that conversation (and the thought of her diminished respect for me) has deterred me from many a withdrawl for the purpose of glutonous behavior.

5) Set some funds aside to have some fun like a special vacation you couldn’t otherwise afford, etc. Get some it out of your system. You do need to treat yourself to enjoying some of your good fortune (not to mention sharing a little bit of sunshine with others).

Thanks, guys! If anyone else has something to add, please do.

PS - I’m going to delete the comments pertaining to this from the other post.

Topics: Budgeting, Credit Cards |

Comments to “Credit Card Question From a Reader”

Chris Says:
July 11th, 2007 at 7:29 pm

Pay it off immediately! I say sit on the rest in a high yield savings account and wait a few weeks to decide what to do with it. Really think it over. Would it be best as a retirement investment (they’re already aggressive in that area)? Emergency fund?

If it were me and I was already paying heavily into retirement, suddenly free of credit card debt, had no other debt besides a mortgage, and had plenty of emergency funds and no kids w/o 529s, I’d throw it into the mortgage.

EMF Says:
July 11th, 2007 at 10:28 pm

Absent the windfall, I would have been putting all the extra payments toward the card with the higher balance and not splitting between them. As far as your FICO score, according to what’s been told to me, a credit balance exceeding 35% of your credit line can hurt your FICO score. So you probably want to knock off your higher-interest-rate Citi card and see where that puts your total debt in relation to your credit line. If greater than 35%, then hit your other card. If less than 35%, I’d still pay it off unless you can find an investment that exceeds 6%, because you’re taxed on the proceeds of investments and don’t get to deduct the interest from your credit card debt.

As far as paying off credit cards over time to help your FICO score, I don’t think that will help. Maybe having an installment loan will help your FICO score. My FICO score used to be over 800, but dropped to 773 because, get this, I paid off my mortgage and have no other installment debt. For details, you can follow the link to my blog and get the exact words from the credit reporting agency on this subject. I’ve decided that a FICO score of 773 is high enough, and I’m not going to submit to the hassle and expense of an installment loan.

You haven’t given details on your mortgage. Is it an ARM with the interest rate about to go up? Is your loan-to-value more than 80%, requiring you to pay PMI? If so, is your windfall big enough to pull it below 80%? If that’s the case I’d consider getting the mortgage balance down so that I could drop PMI and possibly refinance at a possibly lower fixed interest rate, particularly if it’s an ARM. If you’ve improved your FICO score by knocking down your credit balances before applying for a new loan, then you may get an even better interest rate. And with a reduced balance, maybe you could handle a 15-year loan with higher payments but a bit lower interest rate and less interest paid over the life of the loan.

Contingency funds for other purposes are a consideration as well. While your cars are paid for, what kind of shape are they in? Are you about to replace one because it’s on its last legs (and not because you have all this money and want a new car)? If you’re not making car payments, you should set money aside to replace the car, and the older the car the more you should already have set aside. What about your house? If it needed a new roof, or a new furnace/air conditioner, or a paint job, or whatever, would that put you back in debt. Having $10,000 in a high-interest-rate online bank is not unreasonable, if you can do it.

If you paid off your student loans recently, then I infer that you’re still young. If you still have some of your windfall left, consider putting some money in the stock market. Such as an index fund with low costs at a broker such as Vanguard.

Gaming The Credit System Says:
July 11th, 2007 at 11:56 pm

I don’t know anything about paying in full vs. over time. That advice might have been confused with what EMF described above — having installment accounts (vs. rotating accounts) is indeed necessary to maximize your credit score, so if you’re shooting for a high FICO it’s best to not pay off your installment accounts early (it’s easy enough to pay them down to $50 and let them run out their term). But I would certainly like to see the site that gave that advice.

As for the timing of it within the billing cycle, really I don’t see this as being an issue if you’re not trying to get new credit immediately or at some particular date (a mortgage app or something). I’d say, pay it all off ASAP to avoid more interest being charged.

As for the mortgage vs. investment issue, JLP has covered this thoroughly in the past and the general conclusion is not to pay off your mortgage early if it’s got a reasonable interest rate. EMF does provide an interesting scenario above with the PMI etc., and that is something additional to consider. But wait several months before you try to re-finance, if you want to go that route. One FICO/credit-report timing issue that I know for sure is that credit card companies and other lenders sometimes take their sweet time in keeping the credit bureaus up to date. I’ve seen accounts on my credit report 2 to 3 months out of date.

EMF Says:
July 12th, 2007 at 7:29 am

“But I would certainly like to see the site that gave that advice.”

Gaming: Click on the “EMF” link above to be taken to my blog. In the post there, I cut-and-pasted exactly what the FICO score service had to say about improving my credit score.

One thing I’ve noticed from getting my free annual credit report from http://www.annualcreditreport.com/ (and not the other site advertised on TV with “free” in the URL instead of “annual”) is that they all don’t get reported to at the same time. That’s because my credit balance history has different figures for the same month. So as far as timing of payments goes, all I can say is that sooner is better than later.

If you are about to get a mortgage, you should get copies of your credit reports and correct any errors. Actually, you should be doing this on a routine basis anyway. I spread mine out so I do one of the three agencies every 4 months. And you may want to purchase FICO scores from all three agencies, to verify that any steps you’ve taken to improve your score have actually been processed before you apply for a mortgage.

Moneymonk Says:
July 12th, 2007 at 11:27 am

this is a no branier! pay off the debts

Miguel Says:
July 12th, 2007 at 11:38 am

@ PRGal - Lots of good advice above.

I’d add that depending on just how large your windfall is, you might want to be very cautious about talking about it too openly with friends and family, or making any outward changes in lifestyle. If there is one thing I’ve learned, its that money is the last great taboo. People have a lot of loaded emotional issues when it comes to money and how they perceive people with money. If you suddenly have a lot more money than your friends & family, they will start looking at you differently, and I don’t mean that as a positive.

We’re all human, and envy, jealousy, resentment, and judgemental behavior are natural. I’ll admit that I have felt quite envious of friends who have received or stand to receive inheritances. It’s my hang-up - it’s not like I need an inheritance to meet any of my fin’l goals. I’m happy for them, but since I don’t think I’ll ever inherit much of anything, I feel a twing of envy, no matter how much I appreciate my own good fortune. Thankfully, that emotion is in check and has never endangered any relationship.

My wife and I were up until 2am last night discussing how the growing divide in wealth between us and many of our friends and relatives has been creating tension and strain on long-time relationships. She is starting to realize that we have to be a lot more careful about what we say in conversation that might ignite jealousy.

We’ve concluded that we don’t even have to do or say anything to warrant resentment - the resentment will find us no matter what because some people just assume that if you become well off, you’ll naturally become an a-hole. So, its always incumbent on us to try to avoid being stereotyped in that way.

Money can also create tension within a marriage or committed relationship. Did the windfall come to only one of you? Does that mean that the recipient has more say in how to handle the money? Does the money go into a joint account? How does the money affect your estate plan? Should it be willed to one side of the family or another? Should it be shared with other family members? Etc.

The one thing that most people don’t really get about wealth is that it doesn’t make life simpler - it makes it more complex. Much, much more complex. And therefore, you have to expend a lot of time and energy thinking about how to manage it and the emotional issues that come with it.

Gaming The Credit System Says:
July 12th, 2007 at 4:38 pm

@EMF: I meant the advice that PRGal mentioned, not the stuff you wrote about on your blog (which I, as a FICO score gamer, appreciated for its thoroughness).

Evan Says:
July 12th, 2007 at 11:46 pm

I’m really puzzled by everyone that says you should pay off both cards. This is very odd advice.

3.99% is a fabulous rate, pay if off as slowly as possible. Nip the other one in the bud and put the money to pay off the citi card into HSBC or ING or Emigrant where you can earn 5%+.

EMF Says:
July 13th, 2007 at 6:29 am

@Evan:
Two questions:
(1) Will you be able to deduct the 3.99% CC interest on your income taxes?
(2) After paying federal and state income taxes on the interest you get from one of the online banks you mention, will you be getting more or less than 3.99%?

If your answer to (1) is “yes”, please provide a link.

If your answer to (2) is “more”, show me the numbers.

Since the answer to (1) is “no”, and the answer to (2) is “less” for most employed people, the advice to pay off both cards is not “very odd” nor even just plain “odd”.

Brad Says:
July 13th, 2007 at 9:15 am

Evan:

If we were talking about a mortgage– secured, tax-advantaged, not prone to extraordinary rate hikes– then I would agree with your assessment, and I am opposed to paying off a low-rate mortgage early. But for a credit card, unless you’re damn near zero percent, I would much rather pay it off. EMF shows that the quantitative argument doesn’t fall much in favor keeping the debt either.

thomas Says:
July 13th, 2007 at 10:17 pm

pay it off immediately. You already have a mortgage so you shouldn’t worry about your FICO for the short term. zero balance is always better.

I’m suprised to hear that they were paying above the minimum on both cards. They could have saved a lot more interest paying the minimum on the low % card and applying the rest to the high interest card.

thomas Says:
July 13th, 2007 at 10:21 pm

i forgot to say they shouldn’t change their CC payments after they pay the cards off. Just move the money from the CC to an online bank and build up your emergency account, or fund your IRA, or payoff some other debt (car, etc).

sure, you could net about 1% interest from not paying the card off and putting the cash in HSBC or something, but I’m sure you could make more money by dumping the CC and moving those payments elsewhere.

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Credit Card Question From a Reader