Three weeks before my financial world collapsed in September 2008, I departed on an expensive vacation paid for on credit. I had about $60,000 in high-interest debt, but wasn’t worried, because I was closing on a new home equity loan that would consolidate it into a more affordable — and tax-deductible — payment. Bonus season was coming, too, and things looked promising.
Then the economy crashed. My home, which I’d spent thousands to renovate, plunged in value. Instead of a bonus, there was only a pay cut. Investments I counted on to cover our family’s lavish lifestyle were worthless. We didn’t have emergency savings, so I plundered our retirement accounts and our kids’ college savings to pay our family’s mounting bills.
By December 2009, I was months behind on the mortgage and in preforeclosure. I was also behind on my many maxed-out credit cards and even the electric and gas bills. Selling the house was the only option, but the mortgage balance was higher than the home’s value, even post-renovation.
In one short year, all my bad credit mistakes and poor financial decision-making caught up with me. But if you think I’d learned my lesson about how to manage credit, you’d be wrong.
Don’t make these credit mistakes
The biggest mistake I made was laying the blame everywhere but at my own feet. Sure, the economy was terrible, job opportunities were scarce, and my no-money-down mortgage was less-than-desirable. But it was my choices that led to our family’s problems, and not anything else.
When it comes to credit mistakes, I made all the bad, obvious ones. I chose to ignore the mortgage and home equity loan payments when cash got tight. I maxed out our credit cards, paid only the minimums, and maxed them out again. I applied for new credit cards and personal loans to pay off old debts. I did all of this with the certainty that the next loan would be the one that would finally, finally, make our family debt-free. Pretty dumb, huh?
By early 2010, those decisions left me with a sub-550 credit score. If you have bad credit, then you probably already know that paying bills late and maxing out your credit card is bad news. But there are other, more subtle red flags to watch for, including:
- I turned off automated payments.
- I ignored the mortgage payment to pay credit card balances instead.
- I kept spending even when times were bad.
- I assumed that because I qualified, I could afford it.
- I took advantage of every offer that came my way.
- I thought borrowing would help me get out of debt.
I canceled automated bill payments to help with cash flow, but I wound up behind on must-pay items like the utility bills because I didn’t have my spending under control. As the old adage goes, you can’t spend money if you just don’t have it.
What kind of idiot does this, you ask? That would be me! Fun fact: When you skip a mortgage payment, it’s a big red flag to credit card lenders. And when you skip a mortgage payment (or six), your credit card issuers may shut down your accounts. Long story short, make your mortgage your top-priority loan.
As if daily calls from creditors, a home in preforeclosure, and living paycheck-to-paycheck weren’t enough of a reality check, I continued to live in denial. I spent thousands of dollars at Christmas — on credit, of course. I even took a call from my attorney about the short sale while shopping at an expensive boutique. It’s embarrassing to admit, but thankfully, I learned from the experience.
Armed with excellent credit and a nice income, I borrowed until our family was drowning in payments. Do yourself a favor and limit your monthly home loan payment to less than 28% of your pre-tax income. You won’t regret it.
“Hey, look! Another balance transfer offer, and another personal loan offer, too! You know, if I do both, I can keep spending and max out our credit cards again!” Okay, so maybe this exact conversation never occurred, but it may as well have.
Low- and no-interest borrowing can work great for people who are disciplined stewards of money. I mistakenly thought I was one of those people.
No dose of reality slaps you upside the head like losing your home and going broke in front of everyone you know and more than a few people you don’t. It’s not exactly like screen-shotting and posting your $0.63 checking account balance on social media, but it’s not far off.
How I improved my credit score
Two unexpected things helped me face my new reality and rebuild my credit. The first was coming clean about our family’s disastrous financial situation. We didn’t have a choice but to acknowledge our financial problems, which wasn’t fun. But it did help me say, “I’m sorry, I can’t spend money on that right now.” And the experience was oddly freeing.
The second thing that helped was paying off what remained of the credit card debt. I did negotiate some balances for pennies on the dollar — another unwise credit move — but I still owed thousands. However, paying off the remaining balances as promised bumped up my score. And since I couldn’t apply for any new cards, that helped with the overspending, too.
Once the dust settled, I could focus on our family’s dearest goal: Saving money and improving our credit scores so that we could buy a more affordable home.
By 2011, my credit score had improved to over 600, but it still wasn’t high enough for a low- interest home loan. Here’s how I boosted my score over 760 by 2013:
- I got a secured credit card with a $500 limit.
- I kept my credit card statement balance below $100 by only using it for gas.
- I turned meeting payment deadlines into a religion.
- I tracked my credit score.
Secured credit cards are easier to get because they require a security deposit. That’s one reason they’re a great credit-building tool for people with poor or no credit.
This accomplished two important tasks. First, I kept my credit utilization below the FICO-recommended 30%. Second, because I wasn’t overspending, it was easy to repay the statement balance in full every month, which made budgeting easier.
The most important thing to do when you’re building credit is paying your bills on time. And I never missed a deadline once I reestablished automated, in-full payments.
This was effective because seeing my scores rise motivated me to keep going. Every time I paid off a loan balance or hit a new milestone, such as pushing our credit utilization ratio below 30%, I checked my credit report and score through AnnualCreditReport.com. You used to have to pay to see your credit score, but today, you can check it for free through services like Credit Karma.
What I learned from this experience
I learned several lessons about financial responsibility after destroying my credit and rebuilding it. Here are five of the most important:
- Automate in-full payments.
- Keep your credit balances as low as possible.
- Recognize budget trickery for what it is — trickery.
- Strategic credit card spending and repayment habits can help.
- Do not overlook the importance of maintaining a robust emergency fund.
Paying the minimum owed is not good enough. Paying in full and on time is one of the best ways to maintain excellent credit. Period.
FICO guidelines recommend spending no more than 30% of your available credit. However, people who limit credit card spending to less than or close to 10% of available credit while also practicing other smart credit-building habits can push their scores over 800.
Balance transfer offers, consolidation loans, and using a HELOC to reduce payments and increase tax deductions won’t work if you aren’t disciplined about building wealth. Quite simply, there’s no substitute for smart — and honest — money management. Robbing Peter to pay Paul as you continue spending isn’t sustainable or smart.
Now that I’ve recovered financially, I only use my credit card to remit automated payments such as my cell phone bill, auto insurance, and the like. I do not use credit cards for purchases such as clothing that are better paid for with cash. That keeps me below 10% of my available credit, makes paying statement balances in full easier, and helps me earn rewards I can redeem for savings later.
Everyone knows you “should” have an emergency fund, but statistics show that few people do. But take it from me: When your boiler breaks in the middle of winter, fixing the heat is pretty important. You don’t want to have to choose a repairman based on whether or not he takes credit cards. A flush cash account makes unexpected costs more manageable.
When it comes to credit, time and smart habits heal all wounds
With careful credit management and three and a half years of patience and persistence, my husband and I were finally able to secure an FHA loan and buy a new home.
That was in 2013. Our house was the lowest-dollar real estate transaction that month, and there wasn’t a room in it that didn’t need a lot of work. We’re still not finished. We’ve got a leaky bathroom, a junk-filled garage that won’t fit our old cars, and a distressing lack of three-pronged outlets. But it’s ours.
Our finances are not perfect by any stretch. We’re still dealing with the aftereffects of the short sale from all those years ago. We have a list of financial goals a mile long that we’re not close to achieving — and don’t get me started on college debt. But we are determined to succeed because the alternative is extremely unappealing.
A credit score doesn’t measure a person’s worth, but it often speaks to a person’s financial mindset. When you have improved your money game enough to achieve financial independence, you can start living the life you dream of instead of the one bad habits dictate you deserve. Best of all, you’ll know that your possessions truly belong to you — instead of the bank.