The ultimate guide to the debts that must be paid off first to raise the credit score
Debt is like being overweight. For many people, the extra bonus here and a little extravagance there doesn’t seem like a real problem.
However, over time, the little bits build up and one day they wake up and say, “How did that get there?”
The good news is that it is never too late. Paying off debt and improving your credit score are two of the most common financial goals. For people who do it right, they can score victories in both goals at the same time.
Here are answers to the most common debt and credit questions, from expert advice to which debts to pay off first to raise your credit score.
How Paying Off Debt Improves Credit Score
Large debt and poor credit often go hand in hand. That’s why it’s great to know that working toward one goal will help achieve the other goal as well.
Improves usage rate
One of the many factors that affect a credit score is a person’s credit utilization ratio. This is the percentage of revolving credit they use.
Revolving credit is any credit that a person can use over and over like credit cards. If a credit card has a $10,000 limit, anyone can use the credit, pay it off, and then use it again.
It is different from a car insurance, for example. If someone takes out a $20,000 car insurance and pays off $5,000 of it, later on they won’t be able to use the $5,000 for something else.
It is easy for people to calculate their credit utilization ratio.
First, they have to add credit limits to all of their credit cards. Then, they add the credits on all of those cards. When they divide the total balance by the credit line, this is their credit utilization ratio.
The goal should be to have a utilization rate of less than 30%. However, the lower the better. Every dollar of revolving credit a person pays will improve the rate at which they are used.
Creates a record
Another important part of a person’s credit score is their payment history. The reason people have poor credit when they turn 18 is that lenders have no record of telling them if a teen will pay their bills on time.
Suppose it takes two years to pay off someone’s debt. This is an additional two years of reliable payments on their record, which will lead to an improved credit score.
Helps with the debt-to-income ratio
In fact, this does not affect a person’s credit score directly. However, one of the most common reasons for seeking debt repayment and raising their credit score is that they are trying to buy a home. The debt-to-income ratio plays a huge role in qualifying them for a mortgage.
As one might expect, the debt-to-income ratio calculates the percentage of an individual’s monthly income that must go toward debt. It depends on their minimum payment, not how much they choose to pay.
With certain debts such as credit card debt, the minimum payment goes down as the balance goes down. The result is a better debt-to-income ratio.
What debt must be paid off first to raise the credit score
Paying off debt obviously improves an individual’s credit score in several ways. For most people, their debt involves several types of accounts. Here’s how to prioritize.
A credit score looks not only at how much debt a person has but also at the types of debt they have. They can categorize accounts into “good debt” and “bad debt.”
Good debt includes mortgage and student insurances. Investing in a home or a degree can improve a person’s financial situation in the future, making it possible for these debts to be productive.
On the other hand, bad debts do not have the power to improve a person’s financial situation. Includes credit card debt and personal insurances. To boost their credit score, a person should focus on bad debts before good debts.
Determine the percentage of usage
For someone trying to pay off their debts in a way that helps their credit score the most, they should keep the utilization ratio in mind. It is better to pay off their revolving credit before other debts.
For example, if someone has credit card debt in addition to a car insurance, they must pay off their credit card debt first.
Tips to pay off debt and raise your credit score
Even when people know which debts to pay off first, it can be hard to know the next steps. These tips can help you.
Higher interest should have higher priority
As mentioned above, it is important to pay off credit card debt first. For people who have multiple credit cards and have balances, they should focus on the card with the highest interest rate first.
If all credit cards have the same or similar interest rates, it is best to start with the card with the highest balance. This way, the person will reduce the largest monthly interest fee from the start.
The Snowball Method Can Help Motivate
In general, it is best to pay off the largest and most interest-heavy debts first. However, for some people, it is frustrating that it takes so long to cross a single debt off their list.
Those who need some extra motivation can start with the snowball method instead.
In this method, they keep making minimum payments on all their accounts but put additional money into their smallest debt. It’s easier to see progress and stay motivated this way.
Think twice about a 0% interest card.
There is a common ploy to pay off high interest credit card debt. It involves applying for and receiving a new credit card with an introductory interest rate of 0%. A person transfers his debt to that card so that he does not pay interest while paying it off.
This tactic is great if paying off debt is your only priority. However, it can hurt a person’s credit score in the process. First, adding a new credit card reduces the average lifespan of their accounts, which can hurt their credit score.
It’s also common for people who do this to close the credit card that the original debt was in. If they do, it will likely hurt their credit utilization ratio because chances are the new card will have a lower credit limit.
Achieving a better financial position
Paying down debt and increasing your credit score doesn’t just require money. It also requires some research, such as knowing which debt to pay off first to raise the credit score. The above tips can help anyone achieve their financial goals in no time.
For a more practical approach to credit improvement, our credit repair experts can help.