Contributing Writer at Tally
December 10, 2019
You recently made the decision to pay off your debt.
Now, you’re wondering where to start. Focusing on everything at once can be overwhelming. And based on the types of debt you have — and how much you owe — you need to decide which debt to pay off first.
More than half of Americans with credit cards have debt, so this is a good place to start.
As of November 2019, the average credit card debt balance among American households is $5,700. It’s all too easy to feel tempted to use your credit card for everyday spending and accumulate a balance that is well over the average amount.
So, as you embark on your debt repayment journey, you may want to consider the benefits that come with paying down credit card debt first.
On the surface, credit cards may seem like all upside and convenience. But buying whatever you want, whenever you want, comes at a cost.
Put simply: Credit card companies are banking on the fact that you’ll accumulate a balance and be unable to pay it off in full at the end of the month.
If you only make the minimum payment on your credit card, you’ll likely be stuck paying interest, depending on your card’s terms. For reference, the average credit card interest rate is currently 17.25%.
When it comes to paying off debt, every dollar counts. And paying interest on your credit card balance every month isn’t the best use of your hard-earned money.
Another drawback to credit cards are all the accompanying fees. The longer it takes you to pay down your balance, the more fees you’re likely to pay — and you know there’s a fee for just about everything.
Annual fees can range from $50 to more than $500 for a luxury credit card. You’ll also have Late fees creep in if you miss a payment, foreign transaction fees pop up if you decide to travel, and balance transfer fees get in the way if you look for a new card with a lower interest rate.
All of those fees add up. And the longer you carry credit card debt, the more money you waste.
There’s no secret here: Paying down credit card debt is one of the best ways to increase your credit score.
Your credit score is influenced by a number of different things, and payment history is the most important factor — about 35% of your score! If you prioritize making timely payments on your credit cards every month, your credit score should increase.
Another major factor in your credit score is your credit utilization. This is a number that reflects how much of your available credit you’re actually using at any given time. Here’s an example:
You have a $5,000 limit on a credit card and are carrying a $4,000 balance. Your credit utilization rate would be 80% because you’re using 80% of your total available credit.
FICO and VantageScore, the two primary credit score providers, recommend keeping your credit utilization rate at 30% or less. As you pay down credit card debt, your credit utilization should decrease and boost your credit score.
Getting a lower mortgage rate can save you tens of thousands of dollars over the life of your loan — that’s a huge deal! But that mortgage rate is dependent on your credit score.
Paying down credit card debt first not only helps your credit score, but it also lowers your debt-to-income ratio. Lenders use your DTI as an indicator of whether you can afford to repay your loan.
If you have a lot of credit card debt, your DTI will be high. That means your current income may not be enough to comfortably afford your mortgage payments along with all your other debt payments. In general, most lenders don’t like your DTI to be over 40%, though each lender’s requirements are different.
This is why it makes sense to pay down your credit cards first. If you have high-interest cards, make those your top priority — this strategy is known as the debt avalanche method. Paying your cards in order or interest rate (from high to low) maximizes your savings.
Once you pay off a card entirely, you should see a nice little bump in your credit score.
This might be the most important reason of all. Mostly because it focuses on your behavior.
Credit cards provide a daily temptation to spend money that you may not have. It’s all too easy to walk into a store and put something on credit, buy food with a credit card or use your card to cover an emergency expense.
Part of getting out of credit card debt is having an honest conversation with yourself about the real reason you got into debt. And for some, it’s all about spending.
When you pay off credit card debt first, you get the opportunity to stop using your cards and rely on a budget instead. By the time you pay off your balance, you’ll have learned how to control your spending more efficiently to avoid getting into debt again in the future.
We all have to start somewhere. If you have credit card debt, jumpstart the process by paying it off first. You can save money in interest and fees, increase your credit score and most likely learn new ways to control your spending and use credit cards wisely.