Paying Down Your Debt
The reason that it is so important to pay down your debt is that the amount of debt that you have in contrast to your available credit is the second most heavily weighted factor in credit scoring. The lower your balances compared to your credit limits the better your credit score will be. For your credit to excel you need to widen that gap between what you owe and your credit limit.
Recall that the FICO scores gage how much of your limit you are exploiting on each card or on any other type of revolving line of credit that you happen to have that is an open account. The FICO score also takes into account how much of the combined credit on all of your cards you are using. Also factored in your FICO scores is how much progress you are making when it comes to paying down debt on installment accounts such as auto loans and mortgages.
Unfortunately many people mistake reducing what they own for just moving balances around from one account to another. Credit card companies who allow people to bounce their balance from one low-rate card to another enable this. These people think they are earning savings on these rates but nothing could be further from the truth.
In actuality this strategy can ruin credit scores, especially if you are transferring a balance from a high limit card to a lower limit card. This is because the more of your credit limit that you are using on any given card, the bigger the hit on your credit score. So you should never do something like transfer a$1,200 debt from a card with $5,000 limit to one with a $1,500 limit.
Also if you continue to charge on your cards instead of paying down the balance then you are consistently going do more and more damage to your score. The way to improve your score is get off the debt transfer treadmill and make an attempt to actually make a dent in your overall debt.
The usual advice to consumers with debt is that they should pay off their highest rate debts first and use any lump sums to pay off any bills they can afford to pay off in full. This makes financial sense but it doesn’t make sense for your credit score.
Instead you should try doing these two things to make a dent in your debt and pay off balances at the same time.
1. To boost your credit score, prioritize your debts. This will help you see how close the balances are to the account’s credit limits. Pay off the card or other revolving account that is closest to its limit. After that is paid down below 30 percent you can switch to paying of the card that is second closest to its limit. Your goal should be to eventually pay off all of this debt paying 30% on your cards as you go.
2. Avoid consolidating our debts. Many people transfer their balances to a single low rate card or to take advantage of having only one due date. Although it is convenient this can cause problems with your credit score. It is always better to have small balances on a number of cards then a large balance on one card or other revolving line of credit.
However if you’ve already consolidated your loan then you should not try and change it. Applying for new credit or transferring balances again could hurt your score and eliminate any advantages gained through the lower interest rate which is often only in action for a limited amount of time anyway.
Yet another tricky aspect of debt is that the credit bureaus don’t differentiate between the balances you pay off and these that are carried from month to month. The balances reported to the bureaus are the ones that show up on your monthly statements. Even if you pay off your bill in full the day your statement arrives you will likely still have balances showing on your credit report and those will be factored into your score.
Paying your balances in full every single month is an excellent financial strategy. If you avoid carrying a balance form month to month you can be saved hundreds, maybe even thousands of dollars in interest payments over the span of your lifetime.
Another thing to watch out for when you carry a balance are the various things that credit card companies tend to do you (such as raising your interest rates with little or no warning.)
However even if you do pay your balances off in full you still have to be wary of how much you are charging each month. You always need to stay well below your credit limits in order to keep your credit score looking healthy.
As stressed previously so many times in this guide you should never max out your cards and avoid coming close to your credit limits. However even though you are not doing this the amount of the actual credit limit you are using might surprise you.
Usually your balances, (the amount you carry plus the amount you charge) should not exceed thirty percent of your total credit limit at any time. The higher your score, the lower the percentage of your credit limits you would need to use to improve your numbers. For instance, if your score is already in the high 700s or 800s you might need to use 10 percent or less of your limit to boost it.