The ultimate guide on how to pay off your debt first to increase your credit rating
Debt is like weight gain. For many people, the extra treats here and a little ruin there don't seem to be real problems.
Over time, however, the pieces add up, and one day they wake up and say: "How did this happen?"
The good news is that it's never too late. Paying off debt and improving your credit rating are the two most common financial goals. For people who do it right, they can score victories for both goals at the same time.
Below are answers to the most common questions about debts and loans, from expert advice to what kind of debt you need to pay off in the first place to increase your credit rating.
How Debt Repayment Improves Credit Rating
Big debts and bad credit often go hand in hand. That's why it's nice to know that working on one goal will help on the other.
One of the many factors that influence a credit rating is a person’s credit utilization rate. This is the percentage of revolving credit they use.
A revolving loan is any loan that a person can use again and again, for example, credit cards. If a credit card has a limit of $ 10,000, someone can use the loan, pay it off, and then use it again.
This is different from car loans, for example. If someone receives a car loan of $ 20,000 and pays $ 5,000, he will not be able to use these 5,000 for anything else later.
It’s easy for people to calculate their own loan utilization rate.
First, they must add up credit limits for all of their credit cards. Then they add up the balances on all of these cards. When they divide the total amount by the credit limit, this is their percentage of loan use.
The goal should be to get a utilization rate below 30%. However, the lower the better. Every dollar a revolving loan a person pays will improve utilization.
Sets a record
Another important part of a person’s credit rating is his payroll. The reason people have bad credit when they are 18 years old for the first time is because lenders have no entries to let them know if a teenager will pay their bills on time.
Suppose someone needs two years to pay off their debt. This is another two years of reliable payments in their records, which will improve the credit rating.
Debt to income ratio helps
In truth, this does not directly affect a person’s credit rating. However, one of the most common reasons people tend to pay off debt and increase their credit rating is because they are trying to buy a house. Their debt-to-income ratio plays a large role in their mortgage qualifications.
As expected, the debt-to-income ratio calculates the percentage of the person’s monthly income that should go to debt. This is based on their minimum payments, and not on 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 increase credit rating
It is clear that debt repayment improves a person’s credit rating in several ways. However, for most people, their debts include several types of accounts. Here's how to prioritize.
A credit rating does not just look at how much debt a person has, but also at the types of debt that he also has. They can classify accounts as “good debt” and “bad debt”.
Good debt includes mortgages and student loans. Investing in a home or degree can improve a person’s financial situation in the future, making it possible for these debts to be productive.
Bad debt, on the other hand, is not able to improve a person’s financial situation. This includes credit card debt and personal loans. To increase your credit rating, a person should focus on bad debt to good debt.
For those who are trying to pay off their debt in such a way that their credit rating is maximum, they should remember the utilization rate. It is better to pay off your revolving credit earlier than other debts.
For example, if someone has credit card debt and a car loan, he must first pay off his credit card debt.
Debt repayment and credit rating tips
Even when people know which debts to pay first, it can be difficult to determine the next steps. These tips may help.
Higher interest should be higher priority.
As mentioned above, it is important to pay off credit card debt first. However, for people with multiple credit cards who have balances, they should first focus on the one with the highest interest rate.
If all credit cards have the same or similar interest rates, it is best to start with the card with the highest balance. Thus, a person from the very beginning will reduce their largest monthly interest payments.
Snowball method can help with motivation
In general, it is better to pay off large and more interesting debts first. For some people, however, it is discouraging that it will take a long time to delete one debt from their list.
Those who need extra motivation can start with the snowball method.
In this method, they continue to make minimum payments on all of their accounts, but invest extra money in their smallest debt. It’s easier to see progress and stay motivated.
Thinking twice about a 0% interest card
There is a general trick to paying off credit card debt. This includes applying for and receiving a new credit card with an initial interest rate of 0%. A person transfers his debts to this card so that they do not pay interest while they pay them.
This tactic is good if debt repayment is the only priority. However, this can damage a person’s credit rating in the process. For example, adding a new credit card reduces the average age of their accounts, which can damage their credit score.
It is also common for people who do this to close a credit card that had initial debt. If they do, this is likely to hurt their credit utilization, because it is likely that the new card will have a lower credit limit.
Achieving a Better Financial Position
Paying off your debt and increasing your credit rating do not just require money. It also requires some research, such as knowing what kind of debt you need to pay off first in order to raise your credit rating. The tips above can help anyone quickly solve their financial problems.
For a more practical approach to improving credit, our loan repair experts can help.