Expert Q&A Archive
What effect does closing my credit card accounts have on my credit score?
While in undergrad and grad school I took out student loans but still got in over my head with credit debt. I worked two jobs for most of my 20's (I picked one of those low-wage earning social service careers) and finally got out of credit debt about a year ago. During that time I got rid of my credit cards and just used my debit card when I needed to make remote purchases. Since then I have heard conflicting information about whether getting rid of all of my credit cards was a good idea; is it best for one's credit rating to keep a credit card?
My next "question" is...
I am 32, single and recently got accepted to a doctorate program with funding for 5 years (although the program is more along the lines of 8, but I will likely be able to get RA/TA positions to continue the funding support), and have been saving money for the last year to draw from given the stipend will not be year round, and it will not cover all of the expenses I anticipate having, such as my car loan payments. I decided to defer my admission for a year to be able to save up more money and have some I can put towards retirement prior to embarking on this path with a very low income for 8 years or so. At this point I have about $11,000 saved, and anticipate being able to have around $30,000 saved by the time I start the program. I have about $16,000 left (of 45,000) in student loans, and about $12,000 left on my car (1.9% financing). I anticipate the stipend covering all but $200/month of my expenses, provided I put my student loans into deferrment. I know I'll need to use some of the money for moving expenses to get to the program, for a computer, travel while I'm in the program (to go home for holidays, etc), etc.
My main question is that of figuring out how to maximize the money I've saved. I know it's not good to have it just sitting in my bank's savings account, but I haven't felt secure enough in my financial knowledge to know what steps to take (so thanks for this program!). Because I won't really graduate until I'm 39 or 40, it seems like a big priority should be putting a chunk of money into a retirement fund. I also want to have money available for emergencies, as well as to draw from to supplement the stipend while in school. Given I can probably anticipate how much I'll need each year, are there investment options that would allow the money to grow and be accessible at different points in time?
Do you have any ideas/suggestions for how to strategize around investing this money in order to be as financially secure and the least "behind" in investing for retirement when I come out of this doctorate program?
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I'd like to respond to your first question.
Revolving accounts such as credit cards are rarely closed unless you specifically ask the lender to close them. You can call or write to the lender (the contact information should be in your credit report) and tell them you want to officially close the account and have it listed on your report as closed at consumer's request. They must, by law, honor your request.
But before you close all your old inactive accounts, consider the impact doing so may have on your credit worthiness. Closed and open accounts both contribute to your credit score. However, when older accounts are closed, they sometimes fall off your credit report, which can create some potential problems.
If that happens, closing old accounts can actually hurt your credit rating because it will shorten the average length of accounts on your credit file, making it appear you have a shorter credit history than you actually have (longer is better here). It may also decrease your available credit so if you carry balances you may have a higher ratio of current balances to available credit, which may be harmful. It can also affect a positive mix of credit references.
You may have heard that having too much available credit can hurt your credit rating. That may be true of some individual lenders, but Fair, Isaac Co. creator of the popular FICO scores, says they do not consider the amount of available credit as a stand-along factor. In fact, FICO says that closing old or inactive accounts can never help your credit but can only hurt it.
You're to be commended for avoiding credit card debt. But in response to your question about whether you need a credit card for a good credit rating, the answer is "probably." If you have a strong credit score already then it probably doesn't matter if you use a credit card for a while. But I would recommend you keep one open and active for maximum benefit to your credit score. You can use it from time to time for things you'd buy anyway, then pay it in full. You can check your credit report and play "what if" scenarios with your score at MyFICO.com.
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1. Credit Card - This is a balancing act. Credit history is a benefit of using a credit card, as long as payments are made on time and personal discipline can control how much one spends. Also, a credit card is safer than a debit card for purchases due to the fraud protection carried by most credit card companies. If an incorrect charge occurs with your debit card, it could hold-up your money for weeks and cause bounced checks, etc. An incorrect charge on a credit card will cause some minor inconveniences when you deny the charge, and it will not hold-up money you may need to pay rent/others. The credit agencies will look at payment history and length of credit, so it is good to have one credit card that you have had for a longer time (with good payment history), rather than switching cards many times.
2. Doctorate Program - (I'm going to assume that you expect a significant pay raise after receiving your Phd., that you have included your car and all other expenses in your calculated need of $200/month above your stipend, and that you will be able to cover your expenses, during the time the stipend is not active, from other income sources - like a summer job.) It looks like you need at least $2400/year to just supplement your stipend, not including your moving expenses, computer, holiday travel, etc. Although saving for retirement is critical, you need access to this $30,000 during your 8 year study. Assuming you will have $25,000 after your relocation, I have attached a simple Excel file to show use of the $25,000 during your 8 years in school (there is no inflation built into the numbers, so you will likely need more than $2400 each successive year). It assumes investing in some very conservative short-term CDs or bonds. A long-term retirement account would have a more aggressive mix of stocks and some bonds, but it seems likely you may need a significant portion of this $30,000 to sustain you during your study for living and travel expenses.
I suggest you consider retirement needs after you are 50% (or some other reasonable time) through your doctorate program. If you are still on track to have excess money remaining, you can consider funding a retirement account vs. your emergency fund.
Also, consider your transportation needs at school and whether you can reduce your car debt with a lower valued car (or no car), without sacrificing safety and travel needs.
Elizabeth J. Savage:
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First of all I think it is always wise to have a credit card (one) to use for emergencies. The key is to think of it as a bill that must be paid in full at the end of the month or at the worst, when you used it for a big emergency, perhaps 90 days. Debit cards, ATM's and the like are not always handy for emergencies.
As for the sums of money that you have set aside for education. I would set aside a couple of thousand in a money market for a cash reserve/emergency fund that you can write a check on fast if you need it.
The balance of the money it sounds as if you might need fairly liquid. For that reason you might consider staggering a series of layered Certificates of Deposits over an 18 mos to 36 month period. In other words, $5,500 in an 18 mos C.D., and $5,500 in a 36 month C.D. That will give you an opportunity to have access to the money fairly easily while making some return in a relatively "safe" position for your needs.
As for the retirement issue, are you working somewhere now that allows you to put pre-tax dollars into a retirement program that you can ultimately roll over into an IRA when you leave this employment. Maxing out a company retirement plan is usually a good idea. Otherwise, since your financial future is a little uncertain, I would concentrate on funding and finishing your education as quickly as you can so that you can get back in the work force and into a position that will allow you to save for your retirement at that time.
One of your biggest assets is that you are aware that you need to start planning financially for the future. People who already realize that usually accomplish their financial goals because they recognize their importance and seek advice to reach them just as you are already doing.
Gail V. Marquet:
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Congratulations on getting out of credit card debt and getting rid of your cards. I hope you also wrote the credit card companies and closed the accounts. Having to have a credit card to have a credit history is a misnomer. You build credit in so many other ways. Using the debit card for remote purchases can sometimes be a hassle, but is a much better bet in the long run.
Getting your doctorate is a wonderful goal, but if you are doing it to significantly advance your salary, be sure to do a lot of research on salaries in the selected field. In many instances, the salary differential between having a master's and a doctorate is almost insignificant. You have made a wise decision to defer grad school for a year and save a significant amount to tide you over. I would suggest you look only at short term investments such as cd's or a money market account. The rates aren't great, but you will have faster access to your cash when needed - and it appears you will need to access it regularly.
If you do go to grad school, you will need to defer your retirement account plans until graduation. It will be more important for you to maintan an emergency fund during that time. After graduation, you can begin to build your retirement fund. At 40, retirement seems to be coming pretty fast, but you will still have time and earnings to build that fund.
Bettye J. Banks:
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Regarding whether or not to close an account:
The percentage of debt on any account should not exceed 50% of allowable credit. When you close an account and have only open accounts left with high balances (you owe more than 50% of your credit limit) it makes you more than 50% vested in credit. Sometimes an open account with a low balance or even a $0 balance improves your credit score. That's how the FICO and other scoring models work. This is why credit analysis counseling is so important. Just knowing which accounts to pay down and by how much can improve your credit score.
Ultimately, your credit score is determined (1) by how you manage credit (never too much or a non-mortgage debt-to-income of less than 20 %), and (2) your record of orderly (ontime) payments.
Please seek the services of both a counselor at a legitimste credit counseling agency and an investment professional. You did not mention whether or not you had a 401(k) or 403(b) at your current employer,if you do, this is found money and can provide the "seed" for an investment program. A financial planner can help you with this. You should incur as little debt as possible. Paying loans back can be long term and costly.