Episode Transcript
It is possible for people earning over a quarter of a million dollars to still feel like they're broke. And when this happens, it's important they find a way to establish some emergency reserves. In the last episode, we talked about starting that process, and in this episode, we'll cover how to optimize your debts along the way.
Let's get started.
This is Brenton Harrison of New Money, new Problems, and your host for the New Money New Problems podcast. In the previous episode, we talked about the crisis of people earning significant incomes, a hundred thousand $250,000 a year or more, who still report that they are living paycheck to paycheck and unable to cover their monthly expenses with their emergency reserves. We talked about the importance of establishing one month's of expenses before we start doing things like saving for retirement. And the significance of that one month to me has to do with a number of factors.
There are things that are emergencies, like blown tires. That's one of my favorite [00:01:00] examples. I remember seeing a meme that said, you're not really an adult until you've bought four all brand new tires. And I think that's absolutely true. It's a painful thing to do.
But even for things that you have coverage for, auto insurance, homeowners insurance, health insurance, they often come with deductibles. And when you add up all of those things, it wouldn't be a surprise to find out that if the worst happened and all of those things went haywire at once that you could conceivably have to come up with the month's expenses.
And until you have it, all of the extracurricular financial things that you contribute to should stop. You need to have that base level of financial support. That doesn't mean that you stop there. As a matter of fact, I often discourage people from starting back those retirement contributions until they've reached at least three months expenses saved. To me, that's the line in the sand you need to reach before you start diverting some of your financial resources to other goals [00:02:00] or concerns.
Now for some people, three months expenses is plenty. I happen to be the type of person who doesn't keep a tremendous amount of cash in pure savings.
But three months for several reasons is to me the minimum expectation for a high income earner. So now we're talking about the journey from zero months to one month of expenses saved to now three months expenses saved, and we've given you the tools you need to get the ball rolling on the savings element. But what about the debts that you're carrying along the way with you on this journey? Things like high interest car loans, maybe you have money on a home equity line of credit. In this episode, we're gonna focus mostly on credit card debt. It is very tempting to be stressed or look at the balances of those debts as you put everything on pause, save for your savings and saying, am I having the right idea? Is there a way to minimize the damage that can occur while I'm [00:03:00] focusing my efforts on building that cash up?
Well, yes, there are ways to minimize the damage, especially if you fit the profile of a high income, high debt, but high credit, having consumer like the ones we covered when we talked about these quarter of a million dollar earners who are living paycheck to paycheck.
When it comes to credit card debt, specifically, we have covered on our YouTube channel in the past, some ways that you can attack that credit card debt based on your income and the credit score that you're bringing to the table.
We'll put a link to some of those resources in the show notes. And in those videos we talk about if you're a low income earner and have low credit, maybe you could do a debt snowball. But for higher credit borrowers, we discussed potentially using a personal loan or credit card surfing to minimize the impact that interest has on your credit balance and make it easier to make a dent as you try to eliminate that debt in the first place.
A [00:04:00] personal loan is when you go to a lender and you ask them for an installment of cash that you can use for any purpose you please, save for something illegal. It literally is me going to the bank asking if I can have a 10 or a $20,000 loan and getting that loan if I'm approved from that institution.
Now for a personal loan, you have to have at least a decent credit score and a decent income to qualify.
So if you don't fall into that category, you need to watch the videos that I referenced to talk about your options . But for those who are eligible for a personal loan, it gives you some options that can help reduce the interest rate damage that you see from your typical credit card.
It's important to understand, however, that the interest rate on personal loans isn't nothing. In fact, compared to some lower interest debts like a car loan or a home loan, it could be significantly higher.
But a personal loan can offer rates that can be significantly lower than a credit card. And if you're trying to position yourself so that the [00:05:00] payments you're making towards your consumer debt are making a deeper dent every 30 days, it's a potential option.
It is not the first option for a person trying to get to three months expenses because unlike a credit card, which allows you to borrow money over and over and over again, even when you're making minimum payments, a personal loan has to be paid off in full in a given period of time.
So it may be that you're getting relief on the interest rate, but you're not getting much relief in terms of the payment itself.
Because of those limitations, my preferred method for optimizing credit card debt while trying to save for a person who has high income, high debt, but also high credit, is to do what is commonly known as credit card surfing.
Now, credit card surfing is the process of taking a credit card balance from a card that you have where you're paying high interest rates, and transferring that debt to a new credit card, offering an introductory rate that is often 0% for high credit card borrowers.[00:06:00]
It's important to understand that you have to already have good credit in order to qualify for this. This is not something that you can do if you have a 600 credit score. The reason I referenced the profile of the borrowers we talked about in the previous episode is because on average they had a credit score of 7 58, which positions them, that being an excellent score, to do some things that are unique when it comes to credit card surfing. If you have, Experian or Credit Karma, any free service that checks your credit score, they should have some version of what's called a credit card marketplace, where they take your score and they look at different credit card offers and based on your score and that company's metrics, give you an idea of how likely or unlikely you are to be approved for that card for which you might apply.
So if you're watching our YouTube simulcast and following on screen, I'm gonna go to the credit card marketplace on [00:07:00] Credit Karma. And when you go to that screen, there's a number of different credit cards that it's going to pull up, and it's going to allow you to browse certain categories of cards based on your interest rewards cards, cash back cards,
I'm going to click the balance transfer to see these special offers from cards who would offer me that introductory rate of 0% if I transfer debt from one card to their new offering. Now, we're not doing any advertisements for these cards, so we're not talking about the pros and cons of the companies themselves, but if you're following along, One of the first offers that I received is an intro balance transfer rate of 0% for 18 months.
The next card 0% for 21 months and it also is showing me the odds of approval at these cards.
This means if I'm trying to make sure that either the payments that I'm making are having more of a dent while I save, or I'm simply trying to limit the amount I have to pay towards these [00:08:00] cards while I save, I have options where I could transfer debt from one car to another and have in some cases over a year and a half where I don't have to worry about that balance increasing because of a high interest.
Remember that we're not yet at the point where we're determining where any extra money should go in our budget. Right now, all of our efforts are focused on saving And with these two options, be it a personal loan or credit card surfing, you have one that could either fit your budget or it could fit your temperament. Obviously, there is a risk if you put money from one card to another that after that 0% interest period expires, you could still owe the debt and you would not have solved some of the habits that led you to having it in the first place.
If you know yourself well enough to know that's not something you are interested in doing a personal loan may be your. A personal loan may be to your liking. Maybe you don't even think either of these should be an option, and you would rather make the minimum payments on [00:09:00] your card and simply leave it where it is while you focus on your savings.
That is an option as well. We are simply trying to optimize. But if you're listening to these options, and the reason you would choose not to do it is because of a concern about the impact on your credit score, after the break, we'll tell you why that concern may be unfounded. And in some cases these options can even lead to the improvement of your score.
We are focusing on the optimization of debts, specifically credit card debts on our journey to three months expenses saved.
And before the break, I teased that taking advantage of two of these options, those options being
one, being a personal loan, the other being credit card surfing, you could potentially see the improvement of your credit score throughout this process. The reason has everything to do with your credit score.
The reason has everything to do with the elements of your FICO score and how heavily [00:10:00] weighted each of those elements are in determining your final number.
If you've heard me give a presentation about credit, you are well aware that I think for those who are trying to improve their credit quickly, credit utilization is the most important thing to focus on because it's really the only one that you can improve in a quick period of time.
Credit utilization is an expression of the amount of available credit you have borrowed at a given point in time, and it represents 30% of your FICO score.
So how would a personal loan or credit card surfing improve that credit score? Let's start with personal loans. We talked about the fact that with a credit card, you can borrow money again and again and again. Credit card debt is a form of revolving debt. With a personal loan. However, you can only borrow an installment of debt one time.
That is a type of debt called an installment debt. You get an installment of capital one time, you pay it off to your lender.[00:11:00]
When it comes to credit utilization, the great thing for personal loans is that credit utilization only monitors revolving debt. It does not take into consideration what you owe in installment debt.
So let's look at an example of a person who has $10,000 that they've borrowed on a card with a $15,000 limit. In this example, this person has a credit utilization ratio on that card of 67%. They have borrowed 67% of their available revolving debt.
Let's now assume that they go to a lender and they ask for and receive a $10,000 personal loan. Installment debt. They can use that $10,000 personal loan to pay off their $10,000 credit card balance.
They still owe $10,000, but in this process, they have taken their revolving debt balance from $10,000 to [00:12:00] $0, and they have taken their credit utilization ratio from 67% to 0% all while still owing the same debt balance.
Which leads us to credit card surfing.
How is it possible that adding a credit card to your mix could improve your score? As a matter of fact, it would seem that it would do the opposite for both the personal loan and the credit card.
Opening a new account means lowering the average age of your credit, which is 15% of your score.
And while 15% of your score is nothing to sneeze at, it is literally half as much as the 30% of your score that is taken up by your credit utilization. If you open up a new credit card, especially if you're a high income earner that has a high credit score, you will likely get a pretty significant amount of credit that you have available on that newcard.
And when you look at credit utilization, it does not just look at the amount of your available credit you've borrowed on an [00:13:00] individual card. It also looks at the amount of total credit you've borrowed based on your total credit limit. Going back to our example of a person who owed $10,000 on a card with a $15,000 limit, that puts them at a very high utilization rate of 67.
Let's now assume that they go and find a 0% interest credit card that offers them the opportunity for a small fee to transfer their balance from one card to another and maybe have 15 months or 18 months where that balance will remain at 0% interest. Let us further assume that when they get that new credit card, the company offers them an additional $15,000 of available credit.
This extra available capital means that their total credit limit is now $30,000. It has doubled from the 15,000 that they had before, and whether they leave the $10,000 they owe on their old credit card or decide to transfer it to the [00:14:00] 0% option, they now owe $10,000 out of $30,000 of available credit.
They have immediately slashed their utilization from 67% to 33%.
And while there may be some temporary negative impacts by opening that card, like the new credit inquiry that they'll have to take on to do so, and even some lasting effects like the lower average age of their credit, the long term positive impact of having more available credit for a larger percentage of your score is something that can show an improvement in your long-term prospects. And while you're building up those savings, you could be positioning yourself so that when you come out of this period and you're not living paycheck to paycheck and you resumed your retirement contributions, and now you're looking into using your credit to do other things like investment property, buying into a business, starting your own business,
you have the savings to do so. You have the credit score to do so. You have the [00:15:00] lowered debt to do so, and from that point on, it's off to the races.
In the next episode, we'll talk about how to know when you've saved enough and when you can finally start putting extra money back on those debt payments or even putting money back into your retirement account.
So if you like what you're hearing, subscribe to the podcast. And if you haven't already, leave us a five star review and you'll hear from me again sooner than you think.
