Paying down credit cards: Which one first?
You may have read online or heard a financial expert report on television that the best method of paying down the entirety of your credit card debt is to direct your pay-down funds to the credit card with the highest interest rate. While there is merit to that advice, you might choose to pay down your credit cards in a different order, such as paying down — or paying off — the cards with the lowest balances instead.
Financial experts say that as long as your total credit card debt is decreasing, there are benefits to different personally-selected card prioritizing plans. For instance, if you have four credit cards with various balances on them and you choose to pay off the card with the lowest balance, you might enjoy the rewarding feeling of accomplishing one paid-off card. Achieving one zero balance right away can create more confidence that you can pay down your cards, starting this process off with a more satisfying result than devoting a payment to a high-balance card and seeing very little headway month-to-month.
According to the financial website Mint.com, there is also another benefit to accomplishing one or two zero-balance cards. Each of your credit card issuers can check your credit reports at any time through their “account management” processes. If they see that all of your cards have high balances, they could use that information to potentially raise the interest rate on the card you have with them, lower your credit limit or even close your account. Also, your all-important FICO score can improve if you have one or more zero-balance credit cards. Your FICO score is configured using intricate formulas; one of the components of that score does take into account how many lines of credit you have with more than a zero balance, so it’s possible that one or two paid-off, lower-balance cards could boost your FICO number.
If you decide to pay off your highest-limit, highest-balance credit cards first, be aware that some credit card companies may decide to lower your credit limit the moment you pay off a chunk of your balance — a practice that is commonly referred to as ‘chasing the balance.’ Mint.com says that your credit score can benefit from having cards with high limits.
A qualified financial planner can be worth the investment in assessing your credit card balances, limits and even card reward plans. They can also help you create the most advantageous pay-down plan. With a reputable and accredited financial planner on your side, you can learn about the benefits of transferring card balances to lower-interest cards, helping you pay down faster. They can offer you advice on how to avoid unwise balance transfers. While you may be tempted to switch to a credit card with an attractive balance transfer rate but horrendous terms in the small print, you could end up with even higher interest rates than you had before.
Financial experts say that even if it’s upsetting to face your high balances and interest rates, it’s important to do so. You can make a spreadsheet of your balances, record your monthly payments and have an organized plan of attack in front of you, showing the progress you’re making. Some financial planning software, such as Quicken, also offer credit card pay-down interactive tools and charts to organize your payments and help keep track of how many more months until you’re all paid off.
As you pay down your cards, keep in mind that not using them at all — such as freezing them in a block of ice or cutting them up — can potentially hurt your credit score when lenders mark an unused card as inactive. Rod Griffin, director of public education at Experian, says that a dormant card can even potentially be closed for lack of use. Losing that credit limit could hurt your credit score. So even though it seems counterintuitive, it’s wise to use all of your cards every now and then for small purchases you’ll pay off as you go, showing activity and responsible spending, which helps your credit score.
If a credit card account is closed, you’ll lose the important factor of the length of time you’ve had the card in good standing — even with high balances — which can further hurt your credit score. So just like with dieting, it’s best not to go to extremes and stop using your card as you work to pay it down. As long as you’re chipping away at your balances and curtailing over-spending, you can put yourself on a path to being debt-free in a method that still keeps you credit-worthy.