Which Debts Should I Pay Off First to Improve My Credit?

How should I prioritize paying off my debts?

Does it feel like your credit card bills, mortgage payments, or student loans never stop piling up? Although it can feel overwhelming, there are multiple proven strategies to help you get debt-free faster.

Start with the 50/30/20 rule

To build an effective plan for tackling your debt, start with a full picture of your finances.

Create a list of your debts. Record all your debts, including credit cards, personal loans, student loans, and auto loans. Be sure to list the interest rate, balance, and minimum monthly payment for each.

The table below shows how to use this method to divide your income into three groups for budgeting:

Want to see how much you’re spending each month? Use our budgeting tool to stay on top of your finances. 4. Use the money you save to pay off your debts. The two most popular debt paydown strategies are the debt avalanche and snowball methods.

What’s the debt avalanche method?

Order your debts by interest rate. Start with the highest rate and work your way down to the lowest rate.

Here’s an example of the avalanche method:

Let’s look at a scenario where you have an $800 monthly budget and the following debts.

1. List your debts from highest to lowest interest rates. Set aside money to cover all three of the minimum payments—$250 for the credit card, $245 for the personal loan, and $175 for the student loan. The total for your minimum payments in this example is $670 a month.

Following the avalanche approach would save about $6,000 in interest payments and get you debt-free around four years faster than just making minimum monthly payments!

What’s the snowball method, and how does it work?

While the avalanche method is generally the quickest path to becoming debt-free and saving you the most money, some people prefer starting with the snowball method. The snowball method can help you stay motivated by paying off smaller debt sooner and getting quick wins. With the snowball method, begin by paying off your debt with the lowest balance first. Once that’s paid off, move to the debt with the next lowest balance and continue the process. The snowball approach can be a more manageable starting point than the avalanche method, especially if you’re already stressed out about paying back multiple debts. You can do it!

Here’s an example of the snowball method:

With the snowball method, the lowest balance is now ranked first, instead of the highest interest rate with the avalanche method. Your monthly budget is $800.

1. List your debts from lowest to highest balances. Set aside money to cover all three of the minimum payments—$245 for the personal loan, $250 for the credit card, and $175 for the student loan—totaling $670.

Following the snowball method would save you about $4,600 in interest and get you debt-free around four years faster than just making minimum monthly payments.

Now’s the time to take control of your finances

It’s always best to have a plan. Budget your money. Pick a debt paydown approach. And start paying off your debts. You’ve got this!

Which Debts Should I Pay Off First to Improve My Credit?

Review your credit score and scoring factors to find out which accounts you should pay off first. As a general rule, prioritize past-due accounts and high-interest credit card debt over installment loans if you want to improve your credit.

If you’re focused on improving your credit scores, paying down or off certain debts can be an effective route. For many people, focusing on past-due accounts, collection accounts and revolving debt, such as credit card debt, might offer a quick win. However, your unique situation will dictate which debts you should pay off first.

A General Guide to Which Debt to Pay Off First

Your credit scores depend on what’s in your credit reports, and the impact of paying down or paying off a debt can vary depending on your situation. If your goal is to improve your scores, you might want to focus on the following factors:

• Past-due accounts: Getting open accounts that are past due back into good standing can minimize further damage to your credit scores.
• Collections: Paying off or settling collection accounts could improve some of your credit scores. Newer credit scoring models ignore paid-off collections accounts.
• Credit cards: If all your accounts are current, shift your focus to paying down credit card balances. Credit utilization is an important credit score factor that measures the amount of your available credit you’re using. Even if you don’t carry credit card debt from month to month, making early payments could decrease your reported balance and might help your credit scores.
• Installment loans: Paying off installment loans might help your scores, although there are times when paying off the loan will actually lead to a minor score drop instead.

Get Specific by Reviewing What’s Affecting Your Credit Scores

Figuring out what’s impacting your credit scores the most can help you narrow in on which debts you’ll want to pay off first.

If you recently applied for credit and received an adverse action letter, the letter may list the four to five factors that had the largest negative effect on your score. You should receive one of these letters if your application was denied or if you received less favorable terms due, at least in part, to your credit.

You can also check your credit report and FICO ® Score Θ from Experian for free. Within the credit overview section of your Experian account, you can view the “key factors” affecting your score. Experian shows you the five factors that are having the largest negative or positive impact.

Use these results as a guide to the improvements you could make. If there’s a factor that’s clearly related to outstanding debt on a specific account or type of accounts, such as a collections account or high utilization on revolving accounts, you might want to pay off or pay down that debt first.

Revolving vs. Installment Debt

Here’s a brief overview of the general types of accounts and account statuses you may want to focus on to improve your credit score.

Revolving Accounts

A revolving account has a credit limit that you can repeatedly borrow against as long as your total balance stays below the limit. Credit cards are the most common example, but personal and home equity lines of credit (HELOCs) are also revolving accounts.

The balance on revolving accounts can affect your credit scores in different ways, but the most important is your revolving credit utilization ratio.

To calculate your credit utilization ratio, you can compare your revolving account balances and limits as they appear in your credit report. For example, if you have two credit cards with $5,000 credit limits ($10,000 total) and a combined balance of $2,500, your overall credit utilization ratio is 25%.

Many scoring models consider:

• Your most recently reported credit limit and balances
• Your overall credit utilization rate based on your combined balances and limits
• The individual credit utilization rate on credit cards

A lower utilization rate tends to be best for your scores, and some newer scores also consider how your utilization rate has trended over time.

Installment Accounts

An installment loan typically has a fixed loan amount and a set repayment period. For example, personal loans, auto loans and mortgages are installment accounts that often require monthly payments over a predetermined period. If the loan has a fixed interest rate, the monthly payment will stay the same for the life of the loan.

The balances on your installment loans can affect your credit scores in several ways:

• How many accounts you have with balances
• The remaining debt relative to the amount you borrowed
• Your total outstanding installment loan debt

However, your revolving credit utilization ratio tends to have a larger impact on your credit.

How Account Status Can Impact Your Credit

Past-Due Accounts

A past-due revolving account or installment loan could be hurting your score, and the negative impact may increase as you miss additional payments. Try to bring the account current by paying off the balance, or contact the creditor and see if you can get on a payment plan or hardship program that will minimize the impact on your credit scores.

Collection Accounts

If past-due bills don’t get resolved, the creditor might assign or sell the debt to a collection agency. The original account on your credit report could be closed and a new collection account could be reported. Paying off collection accounts might help some of your credit scores and your overall creditworthiness. Settling a collection account can also improve your credit scores, but you might not see as much of an increase.

How to Decide Which Credit Card to Prioritize

Paying down any credit card debt to lower your overall utilization rate might help your credit scores. However, you may want to consider other factors if you have more than one credit card with a balance:

• To save the most money: If you’re carrying a balance on more than one credit card, focus on the card with the highest annual percentage rate (APR). Paying down that balance faster will lead to less interest accruing overall.
• To increase your score the most: Paying down the card with the highest utilization rate first might help your credit scores a little more because scoring models consider individual account utilization in addition to overall utilization.

If one of your cards has a small balance, consider paying off the card completely so you’ll have fewer accounts with balances. Keep the card open and don’t use it to help lower your utilization rate. Or, if you use the card, pay off the balance before the end of each statement period to try to keep a balance from getting reported to the bureaus.

How to Pay Off Debt

Choosing which debt to prioritize can be important, particularly when you want to quickly improve your credit scores. However, you can also strategize your approach to help you get out of debt sooner or pay less overall.

Debt Avalanche and Snowball Strategies

Paying off debt using the debt avalanche or debt snowball method could help you eliminate balances more quickly. With the debt avalanche method, you prioritize paying the most money to the account (usually credit cards) with the highest interest rate first, which can help you save money. Once you pay off your highest-rate account, you’ll focus on the account with the next-highest rate, and so on, until all your balances are paid.

Alternatively, with the debt snowball method, you focus on the account with the lowest balance first. This strategy may be more motivating and easier to follow through with because it could allow you to pay off individual debts more quickly.

Balance Transfer Credit Cards

Balance transfer cards often offer a promotional 0% intro APR on the debt you transfer to the card. You can often transfer balances from credit cards at other issuers, and sometimes from installment loans. Then, you can pay down the balance without accruing additional interest during the promotional period. Many balance transfer cards charge a balance transfer fee, and it’s common for this fee to be 3% or 5% of the transferred amount. You’ll typically need good credit or better to qualify for balance transfer cards.

Debt Consolidation Loans

You might be able to get a personal loan and use the money to pay off credit cards or other loans. This strategy can be helpful if you can qualify for a loan with a lower interest rate than the debt you’re consolidating. Plus, you can focus on a single monthly payment and specific payoff date. Moving debt from a revolving credit card account to an installment loan can also lower your credit utilization rate. As with balance transfer cards, you’ll likely need good credit to qualify for debt consolidation loans with lower interest rates.

Debt Management Plans

If you can’t seem to get a handle on your credit card debt, a certified nonprofit credit counselor may be able to help you get set up with a debt management plan (DMP). A DMP can help lower your payments and set you on a path to paying off the debt, often within three to five years. Although there are initial and monthly fees, the counselor may be able to negotiate fee waivers and lower interest rates that lead to overall savings. One downside is that you generally can’t open or use credit cards while you’re on the DMP.

Monitor Your Progress

Reviewing your credit report can help you determine which accounts are affecting your credit score and make a plan for paying down debt to improve credit. You can also find your accounts’ current balances, interest rates and required monthly payments by reviewing their statements. You can monitor your credit report and FICO ® Score for free with Experian to track your progress with daily updates.

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About the author

Louis DeNicola is freelance personal finance and credit writer who works with Fortune 500 financial services firms, FinTech startups, and non-profits to teach people about money and credit. His clients include BlueVine, Discover, LendingTree, Money Management International, U.S News and Wirecutter.

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