Is it bad to pay off credit card early

Is it bad to pay off credit card early

I am 38 years old and married. Because of a mix of bad luck (multiple lay-offs between my husband and I over the years which led to months of unemployment, unexpected major medical bills), choice (job change years ago led me to switch careers by going back to school and not working for a year) and bad mistakes (lots of credit card spending. mostly just to "survive", but sometimes just frivolous spending), we have acquired a massive amount of credit card debt.

We currently make $115,000 combined gross income (this has just recently increased due to my fortunate job promotions over the past 3 years). 3 years ago we were only making $75K combined and 5 years ago we were making $30K combined. So, I'm very proud of where we are now.

But. back to the problem. We have $65K in credit card debt. I am very strict with our budget but the last year has proven to me that getting that debt down is just not working. We are only paying the minimum on the 11 cards we have for a total of $1500 a month in minimum payments. Our income per month is exactly equal to our expenses. We are so extremely stressed and it's been like this for years.

I never, ever considered doing this until now but I really, really think it's the best way to get debt free and get out of this hole. We are considering cashing out our IRAs and 401Ks to pay off this credit card debt. We currently have $70K in these investment funds. If I'm doing the math correctly we would have about $40K after tax penalties to pay off most of this $65K debt (we would only withdraw $60k of the $70k of investment funds in order to stay within 25% bracket. see below about that).

Every Feb we receive $4K in bonuses and about $2K in taxes so we would be able to pay off the remaining $25K in 2 years (because we would also be able to pay $500 per month toward the $25K because of the $1000 of month savings we would have by paying off the $40K). After the credit cards are completely paid off we will have at least $1500 a month and can really focus on quickly saving for retirement. Currently we aren't even investing in our 401Ks because we can't - there is no extra money for it and I don't see that changing any time soon because there is just no extra money at all. Let me also add that we also have $15K of personal loans and $20K of auto loans which equal $1100 a month in payments. I have $45K in student loans which I have been deferring for years now and next April I have to start paying on . no more deferment allowed. That will be $400 a month. We also have $50 in savings and that is it. That really, really makes me very nervous.

It's all a mess, I know. I need some kind of reassurance that we are making the right decision to do the early withdrawal. I know most people will say it's a stupid thing to do, but I truly feel it's our best choice. I will not consider bankruptcy. And we are not going to sell our house or cars. There is no more cutting of expenses.

A couple of questions:

  1. We are currently in the 25% tax bracket. I was thinking we could make one withdrawal before the end of this year of $30K and still stay within the 25% bracket and then early next year make another withdrawal of $30K to again stay within the 25% bracket. At least by doing two separate withdrawals we are avoiding the 28% bracket and saving a little of money. I also am aware of the 10% penalty. Am I thinking correctly and can I do the 2 separate withdrawals?
  2. Is there anything else I'm missing? How would the withdrawal affect my taxes on my regular income or would that just remain the same? In other words in Jan when I do my taxes I'm assuming I would just show that I made $145K for 2014 (our $115K income and the $30K withdrawal) and we would be taxed on that.

Oh - and it goes without saying - we are through with credit cards. If we don't have the cash, we will not be going on that vacation or buying that product. It's just how it is. Thanks for any advice!!

Edit --- All very good points. Yes we have accumulated quite a bit more expenses just recently. My daughter just started attending private school in the last year and we pay 500 a month. Prior to that we paid nothing for daycare. Also we purchased a car for me a year ago which is 375 a month. Probably shouldn't have done it but the car I was driving was on it's last leg. I hadn't purchased myself a car in 10 years and hadn't had a car payment for 7 years. I thought about the 401k loan idea. Honestly it just sounds so wonderful to be nearly debt free and to have 1500 a month extra to not have to pay credit cards and that is why the ira withdrawal is oh so appealing. I'm so sick of this debt (I know it's my fault). The 401k loan is an option. Only problem is that my husband and I have worked less than 3 years at our jobs and haven't accumulated very much in the 401k. He has 13k and I have 9k. But - we do have 45k in iras. Last night I did some research and read about reverse rollovers which I hadn't heard of before. Do you all know much about it? That is - rolling over the ira money into our 401ks. If we can do thag and take out 50 percent we could get app 35k to use toward our debt which would be great. Instead of 1500 a month we would spend about 1050 a month (630 from the 401k loan and 425 for the remaining credit cards). Not sure if I would be able to do that at work. I work for the fed goby and I doubt they allow a reverse rollover. Honestly though I'm still very tempted to just cash out all of the iras and 401ks and just pay off 40k of the debt and only pay 425 toward credit cards per month instead of 1500 (or 1050 by the 401k route). Thoughts??

Paying off a Debt Early Won’t Help Credit Scores

I have a friend who took out a personal loan just so she could build up her credit. She’s nearly 40 with no credit. She still has six months of payments to make on it. I was wondering if it is bad to pay it off early or does that help her?

Your friend was correct that in order to establish a credit history she must first have a credit account opened in her name.

While paying the loan off early may save her some interest fees, it is better for her credit history to leave it open until she has been approved for other credit accounts. Open and active accounts are scored more highly than closed accounts because they demonstrate that you are managing credit well now and not just in the past.

However, it can still be a positive start to her credit history, even if closed. The important thing is that all payments were made on time. She also should review her contract carefully to ensure there is no early repayment penalty. Such a penalty will not affect her credit history, but could result in additional expense.

With an established credit history, she may be able to qualify for a credit card. If so, she should give serious consideration to getting one. A credit card will help her build a strong credit history and credit scores more quickly.

Unlike an installment loan that sets a specific payment amount each month, a credit card allows the holder to decide how much they want to charge and how much they want to pay each month.

Because the holder makes these decisions, credit card use provides much greater insight into how the individual will manage other accounts. As a result, credit cards play an important role in establishing strong credit scores.

4 Reasons to Pay Your Credit Card Bill Before It’s Due

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There are many good reasons to never pay your credit card bill late, but are there any good reasons to pay it early? It would seem to go against all common sense to send in a payment well before the due date, but the more you understand about how credit cards and credit reports work, it can be smart idea under some circumstances.

Here are four reasons why you might consider paying your credit card early.

1. Save Money on Interest Charges

When you carry a balance on your credit card account, you accumulate interest charges each day, based on your daily balance. So when you make a payment before the due date, you are lowering your average daily balance, which can reduce your interest charges significantly. Also, think of it this way: Since you earn very little interest from keeping money in a checking or savings account, but pay much more for that high-interest credit card debt, you stand to save money in the long run by making payments to your credit card as soon as possible. If you want to know how long it will take you to pay off that balance, this calculator can help you.

When your statement period ends, and a statement is issued, that balance is reported to the major credit reporting agencies as debt, even if you ultimately avoid interest by paying your balance in full by the due date. That reported debt can lower your credit score if your balance is high during a particular month. By paying off all or some of your balance before the statement cycle even closes, you can reduce your debt-to-credit ratio and improve your credit score (you can see how this factor is affecting your credit scores by checking your free credit report data on Credit.com). This can be an especially important factor when you are applying for a home mortgage or another line of credit.

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By making an early payment, you are committing your funds to paying off your debt, rather than merely planning on doing so in the future. Without having those funds available for other discretionary expenditures, you are unable to change your mind and spend the money elsewhere.

If you anticipate making a large purchase, you can quickly use up your line of credit before a payment is even due. This is especially true when you consider that the typical statement period is about 30 days long, and your grace period, the time between statement closing and the payment due date, can be 21 to 25 additional days. And if you are traveling and have holds placed on your account by hotels or rental car agencies, then you may have even less of your credit line available by the time the due date arrives. By making early payments, you can free up your line of credit and ensure that all of your charges are approved.

When Not to Pay Your Bill Early

While there may be some very good reasons for cardholders to pay their bills early, it won’t make sense for everyone. If you are always avoiding interest by paying your statement in full, and you aren’t using a large amount of your credit line, then waiting until just before your due date to make a payment can be ideal. In this situation, you aren’t saving any money on interest charges, and your funds will remain available to you in your bank account for as long as possible.

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Jason Steele has been writing about credit cards and personal finance since 2008, poring through the terms and conditions of credit card agreements to understand the minutiae of how these products work. His work has appeared on Yahoo, MSN, HuffingtonPost and other major news outlets. In his free time, Jason's a commercial pilot. He graduated from the University of Delaware with a degree in History.

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Keep in mind that by paying off your credit card statement early, you negate any benefit that your card may give you in terms of rewards or cash back. Rewards and cash back are normally calculated against the balance on your credit card statement, so if you pay it off early, you won’t earn any of the rewards on the amount that you paid early.

Smart to check the terms of agreement. What you say may be true for some cards, but it is not true for all.

That is not correct. Dollar spent is dollar spent…cashback only on balance, now that’s just silly.

This advice can work against you. Last month I made a partial payment one week before the statement was issued and the rest before the due date, only to discover $100 worth of interest on the next statement. The reason? My early payment was applied to the previous month (whose balance was zero because I already paid in full) and since the second payment didn’t by itself cover the entire statement, I was charged interest on the difference. Yes, I was charged interest because I overpaid and my account was in credit. I may be the only person on the planet who’s dumb enough to pay before the billing period is done – apparently their computer systems can’t handle it.

3 Good Reasons to Pay Your Credit Card Bill Early

Your credit card statement comes with a due date, just like any other bill. But unlike with your Netflix subscription, your electric bill or your rent, paying your credit card bill before the due date has benefits beyond the peace of mind that comes with not having to deal with it for another month.

Paying your credit card bill early can save you money, boost your credit score and give you flexibility in your budget.

1. Paying early means less interest

First things first: If you pay your credit card balance in full every month, you won’t have to worry about interest. That’s because issuers give paid-in-full accounts an interest-free grace period, which usually lasts until the next due date.

If you aren’t going to pay the full amount, then pay what you can as far ahead of the due date as you can. Your interest charge is usually calculated using your average daily balance during the billing period. When you pay ahead of your due date, you reduce your average daily balance.

Say you have a balance of $1,000 on the first day of your billing cycle, and you’ll only be able to pay off $600. Assuming a 30-day cycle, if you waited until the due date to pay, your average daily balance would be $980.

($1,000 x 29 days) + ($400 x 1 day) = $29,400.

$29,400 / 30 days = $980.

Now say you paid that $600 on the 21st day of the cycle. Your average balance becomes $800.

($1,000 x 20 days) + ($400 x 10 days) = $24,000.

$24,000 / 30 days = $800.

You can save even more when you “pay as you go” — making multiple payments as the month goes on. Say you paid $200 on the seventh day of the cycle, then $200 on the 14th and $200 on the 21st. Your average daily balance drops to $660.

($1,000 x 6 days) + ($800 x 7 days) + ($600 x 7 days) + ($400 x 10 days) = $19,800.

$19,800 / 30 days = $660.

Paying the same amount on your credit card but paying it early and in installments reduced the interest in this case by nearly a third.

2. Early payments can improve credit

Taking care of a credit card bill early reduces the percentage of your available credit that you’re using. That’s good for your credit score.

The credit utilization ratio measures what you owe on your credit cards as a percentage of your available credit. For example, if you have only one credit card with a $10,000 limit and a $9,000 balance, your credit utilization would be 90%. Credit scoring models consider it a bad sign when you use a large amount of your available credit, since that could signal financial trouble. In general, using less than 30% of available credit is preferable, and using less than 10% is ideal.

Your credit card information is usually reported to credit bureaus around your “statement date.” That’s the day your statement is prepared and sent to you. Paying early, before your statement is prepared, can reduce the balance reported to the bureaus and therefore the utilization ratio used in your credit scores.

3. Paying ahead clears room for other needs

Paying ahead of time also frees up your available credit for holds or purchases. To make big purchases on your card, you’ll need room to spare in your available credit. It’s possible for a card to be declined when you use most of the available credit or get close to a card’s limit.

Exceeding a card’s limit has consequences. Many issuers no longer charge over-limit fees, but they could decrease your credit limit or close the account. Interest rates can also go up on other cards if your credit history shows you make a habit of going over the limit. You would appear risky to potential creditors, and your score would suffer. So especially if you’re close to maxing out, pay down your balance ASAP.

An added incentive for early payments

There’s another, more exciting reason to pay a credit card bill ahead of schedule. Interest can cancel out the value of credit card rewards such as cash back and travel miles. Slash your interest by paying early — or better yet, wipe it out by paying in full. This way, your credit card issuer pays you at the same time you pay them.

A Service to Pay Off High-Interest Credit Cards, but a Bad Time to Start

The promise that a new service called Tally makes to people with credit card debt is simple enough: Its app scans a picture of your cards, and you agree to a credit check. Then, let Tally pay off your high-interest cards using a new line of credit with a lower rate.

But Tally’s problem is that it is starting up at the exact moment when a similar lender, Lending Club, is in deep trouble with regulators and the financiers who make its business possible.

Tally could save plenty of people hundreds of dollars in interest and fees a year. But should consumers and others whom the company needs to succeed actually trust it?

First, a question: If car loan rates for people with good credit are often below 5 percent and mortgage rates are below 4 percent, why do consumers generally pay 15 or 20 percent annually to borrow money from credit card issuers?

Experts have a couple of answers. According to Marc Sacher, executive vice president at the Auriemma Consulting Group, that baseline interest rate is not the whole story for consumers with good credit. After all, banks are offering all sorts of zero percent interest teaser rates that last for a year or more, which brings down the effective interest rate. But, he added, those baseline interest rates remain high because of regulations that often make it harder for card companies to raise rates for existing customers.

David Robertson, publisher of the payments industry newsletter The Nilson Report, points to another factor. Overall balances in the card industry fell significantly during the economic downturn and haven’t fully recovered. People are paying off their balances more than they used to. Moreover, card companies are spending a fair bit of money to pay for reward programs to entice and retain people who never carry a balance. So if you are a card issuer in that environment, would you willingly lower your profit by lowering interest rates, effectively telling your shareholders to take a hike?

No, you wouldn’t. But Tally’s founders, Jason Brown and Jasper Platz, who have venture capital backing from Shasta Ventures and Cowboy Ventures, aren’t worried about bank shareholders.

Before Tally, they started a business that helped consumers borrow money for solar panel installations. After they sold that company, their search for a new project led them to ask why people with great credit did not get rewarded with better interest rates on their credit cards.

Tally makes its credit lines available to customers with at least a 660 FICO credit score, though you will need one that’s a lot higher to receive its best annual percentage rate, which is 7.9 percent. Most people will pay at least a bit more than that. For now, the highest rate is 19.9 percent.

A loan from the company is like a credit card in that the rate is variable and it comes with a credit limit, which will also depend on the credit score. That line may or may not be high enough to pay off all your existing card debt.

Tally is a convenience tool, too. You pay Tally once a month, no matter how many cards it is handling on your behalf. That payment, depending on its size, covers all of the minimum payments on your cards, plus new charges and any lingering Tally debt.

Tally requires its own minimum payment, as a card company would. But you can pay as much on top of that as you want, which the company puts toward your highest-rate debt. Tally charges no origination, annual, prepayment, late or over-the-limit fees.

This is no giveaway, though. Tally gets the money to pay off your cards by bundling the loans it has made to other customers and selling them to investors as asset-backed securities. (Credit card issuers have been doing this for decades now.) Mr. Brown boils it down like this: Tally gets money for one price (from the investors who buy that bundle) and sells it (to consumers) at a higher price. It keeps the difference, minus any losses that it has to cover and whatever it needs to run its business.

The business model won’t work, however, unless the loans Tally gives to consumers cost less than the interest rate their card companies are charging. Otherwise, why would anyone bother signing up?

So why would a consumer take a chance on Tally? After all, personal loans are available to people with great credit from established banks like SunTrust, whose interest rates start at a mere 4.99 percent if you pay off the loan fast enough.

Mr. Brown contends that the two products are not comparable. Personal loans are generally for a fixed length of time, but Tally’s line of credit is open-ended, like a credit card. He is at least partly right, but for people determined to get out of debt and stay out, a personal loan that lasts for a set period can provide a better form of discipline.

Plenty of people with credit card debt may also simply move it from one card company to another every 12 to 18 months, taking advantage of zero percent balance transfer offers. This can work well, as long as the borrower doesn’t miss any payments and the offers keep coming.

I worry more about what may happen once people do sign up with Tally. Its user agreement makes a big deal of the fact that consumers are responsible for helping Tally maintain the links between its own software and the credit card issuers’ websites.

Anyone who has done business with the financial dashboard service Mint knows how often those connections mysteriously break down. Mint is mainly a tracking service. Tally has to actually make your payments or you get into trouble with your card companies.

Mr. Brown said Tally built redundancy into its system by working with more than one aggregator, the third-party services that manage connections with bank sites. Moreover, Tally has a manual payment plan ready if all else fails. Given that it needs to pay your bank on your behalf only once a month, the company assumes that customers will help it resolve any issues before late payments become a problem. We’ll see.

The company also reserves the right to suspend payments to card companies and withdraw a line of credit after two months of missed or returned payments. You pay via a direct link from your bank account, though automatic payments are not required. That means you can choose when to transfer money to Tally each month.

Tally has its own risks, too. “It’s slamming headfirst into headline risk,” said Mark Adelson, a Tally adviser who is an expert on asset-backed securities and the former chief credit officer of Standard & Poor’s. “There is all kinds of mayhem around Lending Club.”

Mr. Adelson imagined himself as an analyst at an insurance company who helps figure out which asset-backed securities to buy. Then, he imagined his boss stopping by his cubicle for a word. “‘We don’t have any of that Lending Club paper, do we, son?’” he said. “The right answer is, ‘No, sir, we don’t.’”

If Tally can’t eventually sell its securities, it will probably not last long. For now, Mr. Brown said, it has large financial commitments from both Silicon Valley Bank and a high-net-worth family that is an experienced purchaser of such securities.

“All we’re doing is shifting accounts from Chase” — or another bank — “into a different pool that has the exact same risk profile, and giving institutional investors access to that,” he said.

The company, in a bid for transparency, plans to let investors log into its site and see how its loans are doing, in aggregate, at any given moment. When I asked Mr. Brown to promise to tell the truth about every loan that it packages into a security, he said the company would.

As for thoughts on Lending Club, he put on a brave face, which is about the only thing you can do when a company a lot like yours gets into trouble just as you’re opening for business. “We want there to be scrutiny,” he said. “The more scrutiny there is, the more legitimacy there will be in the long term.”

While asset-backed securities peddled by a couple of guys who used to finance solar panels may seem dicey, Mr. Adelson said he was not concerned. “It’s really about using credit cards better and smarter,” he said. “Pay down the highest rates first. Don’t pay late. Stay aware of what you owe by pooling things into one master account.”

Sure, it would be best if people didn’t carry any card debt. But we’re a long way from that happening. “Anything that helps people manage that debt better,” Mr. Adelson said, “is a good thing.”

A version of this article appears in print on May 21, 2016, on Page B1 of the New York edition with the headline: Timely Idea on Credit Card Debt. Bad Timing. Order Reprints | Today's Paper | Subscribe

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