Dear Liz: In about three months, my wife and I will receive close to $20,000 thanks to an inheritance. We have six credit card accounts with balances totaling about $10,000, plus two car loans with $10,000 and $11,000 balances, respectively. The smaller of the two car loans carries a 19% interest rate, so we know we’re going to pay that off. The other vehicle is financed at about 4% and has about three years’ worth of payments remaining, so we’re likely to leave it as is. With the remaining $10,000 we would like to pay off our credit card debt and close some of the accounts so as to improve our credit scores. I have heard of banks cutting credit limits when people make large payments on their credit accounts. Because of our very high balance-to-limit ratios, our credit scores are around average — in the mid-600s. Should I be concerned about this, and is it possible to avoid?
Answer: Your scores are actually below average. The median FICO credit score in the U.S. is between 700 and 720.
You’re not going to improve your scores by closing accounts (that can’t help scores, and may hurt them). And your credit card issuers may well cut your limits when you pay down your debt.
But that should be the least of your concerns. Your credit card balances indicate you’re living beyond your means. Fewer than 1 in 10 U.S. households has credit card debt of $10,000 or more, and carrying credit card balances not only erodes your financial well-being through expensive interest payments but also puts you at greater risk of bankruptcy.
So use your windfall to pay off your high-rate debt and then create a budget that ensures you spend less than you make so you don’t run up future debts.
By the way, it’s a bit unlikely that both of you are receiving an inheritance. Typically the money comes to one half of a couple and can be kept as separate property if he or she so chooses.
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