An in-depth guide on how to pay off debt and improve your credit score in the process

An in-depth guide on how to pay off debt and improve your credit score in the process

The ultimate guide to what debt to pay off first to boost your credit score
Debt is like weight gain. For many people, an extra treat here and a little waste there don’t seem like real problems.

Over time, though, the pieces add up, and one day they wake up and say, “How did it get here?”

The good news is that it’s 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 wins on both goals at the same time.

Below are answers to the most common questions about debt and credit, from expert advice to what debt to pay off first to boost your credit score.

How paying off debt improves your credit score
Heavy debt and bad credit often go hand in hand. That’s why it’s great to know that working toward one goal will help the other.

Improves utilization rate
One of the many factors that affect a credit score is a person’s credit utilization ratio. This is the revolving credit rate they use.

Revolving credit is any credit that a person can use over and over again like credit cards. If a credit card has a limit of $10,000, someone can use the credit, pay it off, and then use it again.

It’s different from a car loan, for example. If someone gets a $20,000 car loan and pays off $5,000 of it, they can’t later use that $5,000 for something else.

It is easy for people to calculate their own loan utilization ratio.

First, they need to add up the credit limits for all their credit cards. Then they add up the balances of all those cards. When they divide the total balance by the credit limit, that’s their credit utilization rate.

The goal should be a utilization rate below 30%. However, the lower the better. Every dollar of revolving credit a person pays off will improve their utilization ratio.

Creates a record

Another important part of a person’s credit score is their payment record. The reason people have bad credit when they first turn 18 is because lenders have no data to tell them if the teenager will pay their bills on time.

Let’s say it takes someone two years to pay off their debt. That’s two extra years of reliable payments on their record, which will do improve credit rating.

It helps with the debt-to-income ratio
In fact, it does not directly affect a person’s credit score. However, one of the most common reasons people are looking to pay off their debt and improve their credit score is because they are trying to buy a home. Their debt-to-income ratio plays a big role in qualifying for a mortgage.

As you might expect, the debt-to-income ratio calculates the percentage of a person’s monthly income that should go toward debt. It’s based on their minimum payments, not the amount they decide to pay.

For certain debts, such as credit card debt, the minimum payment decreases as the balance decreases. The result is a better debt-to-income ratio.

What debt to pay off first to improve your credit score
It is clear that paying off debt improves a person’s credit score in several ways. For most people, however, their debt includes several types of bills. Here’s how to prioritize.

Bad debt
A credit score doesn’t just look at how much debt a person has, but also the types of debt they have. They can categorize accounts into “good debt” and “bad debt.”

Good debt includes mortgage and student loans. Investing in a home or a degree can improve a person’s financial situation in the future, making it possible for those debts to be productive.

Bad debt, on the other hand, does not have the ability to improve a person’s financial situation. This includes credit card debt and personal loans. To improve one’s credit score, one should focus on bad debt before good debt.

Consideration of the utilization factor
For someone trying to pay off their debt in a way that helps their credit score the most, they need to keep their utilization ratio in mind. It’s best to pay off their revolving credit before other debts.

For example, if someone has credit card debt as well as a car loan, they must pay off their credit card debt first.

Tips for paying off debt and improving your credit score
Even when people know which debts to pay off first, it can be difficult to understand the next steps. These tips can help.

Higher interest should be higher priority
As mentioned above, it is important to pay off credit card debt first. For people with multiple credit cards that carry balances, however, they should focus on the one with the highest interest rate first.

If all credit cards have the same or similar interest rates, it’s best to start with the one with the highest balance. In this way, the person will reduce their biggest monthly interest from the beginning.

The snowball method can help with motivation
In general, it’s better to pay off larger, higher-interest debts first. However, for some people, it is discouraging that it will take so long to cross a debt off their list.

Those who need extra motivation can start with the snowball method instead.

With this method, they continue to make minimum payments on all their bills, but put extra money toward their smallest debt. It’s easier to see progress and stay motivated that way.

Think twice about a 0% interest card
There is a common trick to paying off high interest credit card debt. This includes applying for and getting a new credit card that has an introductory interest rate of 0%. The person transfers their debt to this card so that they pay no interest while paying it off.

This tactic is great if paying off debt is the only priority. However, it can damage a person’s credit score in the process. For one thing, adding a new credit card lowers the average age of their accounts, which can hurt their credit score.

It’s also common for people who do this to close the credit card that had the original debt. If they do, it will likely hurt their credit utilization ratio, as chances are the new card will have a lower credit limit.

Achieving a better financial situation
Paying off debt and improving your credit score doesn’t just take money. It also requires some research, such as knowing what debt to pay off first to boost your credit score. The above tips can help anyone tackle their financial goals in no time.

For a more hands-on approach to improving your credit, our credit repair experts can help.

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