In the race to achieve the best possible financial situation, the question of whether to build your credit or pay off debt first comes up a lot.
The good news? You actually don’t have to choose!
When it comes to paying off debt and building credit, these two goals can work very well together. Here’s how.
How does paying off debt help you build your credit?
Personally, I don’t see how building credit and paying off debt are considered opposing goals. Generally speaking, the things you do to better your finances can better your credit – unless you decide not to use credit at all.
In fact, paying off debt can greatly improve your credit thanks to your credit utilization ratio. Essentially the lower your revolving debt, the better your credit utilization ratio. And the better your credit utilization ratio, the better your credit score will be.
Here’s how it works. Say you have a credit card with a $5,000 balance and a $10,000 limit. Divide your balance by you limit, multiply by 100, and you’ll see that you’re using 50 percent of your available credit. Therefore, you have a 50 percent credit utilization ratio.
Now say you have four credit cards, each with a $2,500 limit. Credit card A has a $500 balance, credit card B a $1,000 balance, and credit cards C and D each have a $1,750 balance.
Add them all up and you’ll find that you have a $5,000 total balance and a $10,000 total credit limit. You’re using 50 percent of your available credit and thus have a 50 percent credit utilization ratio.
Here’s a visual example from Experian.
And if you’re wondering why we’re spending all this time talking about credit utilization, just know that it makes up 30 percent of your FICO credit score. It’s also highly influential on your VantageScore.
FICO and VantageScore, the two most popular credit scoring models, both recommend keeping your credit utilization at 30 percent or less. This is yet another reason to pay off your debt as quickly as you can.
What are the best ways to pay off debt?
Now that it’s clear how important debt payoff is if you want to build your credit, let’s talk about the best ways to pay off debt.
Two popular ways to pay off debt
In the world of debt payoff, debt avalanche and debt snowball reign as the most popular methods. The debt avalanche method requires you to pay your highest interest rate accounts first. Debt snowball, however, requires you to pay your lowest balance accounts first. Based on which method you choose, you’re going to pay your debt off in a certain order.
Here’s how to figure out which method is right for you:
- Make two lists of your debt accounts (credit cards, student loans, mortgage etc.).
- One one list, write out the balance next to each (from lowest to highest). This is your debt snowball list.
- On the other list, write out the interest rate next to each (from highest to lowest). This is your debt avalanche list.
Take a look at your two lists. If you’re in desperate need of motivation, the debt snowball can provide you small wins to keep you going from the beginning. But if you want to choose what makes more sense mathematically, the debt avalanche will get you out of debt faster.
No matter which method you choose, the first account on the list will be called your target account. Here’s what you’ll do next:
- Make minimum payments on all your accounts.
- If you have extra money available, apply that only to your target account.
- Once your target account is paid off, apply everything you were paying on that to your next target account – on top of the new target account’s minimum payment.
- Keep doing this – never lowering the monthly amount you pay – until you’re completely debt-free.
The most important thing is that you pick the method you’re most likely to stick with.
Lowering your interest rates
Besides targeting your debt payoff, there’s another useful method to paying debt off faster: lowering your interest rates.
One way to lower your interest rates is simply to ask. Believe it or not, you can call your credit card issuer and ask them to lower your interest rate.
This is more effective for those who have a long history with that card or issuer and who’ve never paid late. That’s because the credit card company wants to keep you as a customer and is more willing to lower your rate.
When you call, highlight any positive history you have with them. Don’t take the first no for an answer. Keep asking to speak to a supervisor until you either get a lower rate or get a final “no.”
You can also lower your rate by consolidating your credit card debt onto a balance transfer credit card. Balance transfer credit cards often come with a zero percent interest rate for a limited period of time and are specifically used to pay off other credit cards.
As long as you either pay off your balance transfer card before the introductory period is over or get another balance transfer card right before it ends, you can work on paying off debt without interest getting in the way.
And if you don’t want to deal with another credit card, you could also try to consolidate your debt with a debt consolidation loan. Just make sure the loan comes at a lower interest rate than your credit card.
If you’re curious to see how much consolidation might expedite your debt repayment, use this calculator to find out.
Credit Card Consolidation Calculator
Principles to follow to build your credit
Whenever you’re trying to establish your financial priorities, remember that good financial habits can enable you to build your credit in a positive way.
And don’t think you can avoid credit altogether. Credit scores, after all, rely on you having some credit behaviors to measure.
The thing to remember when building credit is that the principles are simple. Pay all your accounts on time, keep your debt as low as possible, and only apply for credit only when you need it.
These behaviors will show creditors that you can manage credit responsibly. And for that, you’ll benefit from easier credit approval and lower interest rates. In other words, you can access credit when you need it and more of your money goes to the balance than interest.
Interested in a personal loan?Here are the top personal loan lenders of 2020!
|Lender||APR Range||Loan Amount|
|5.99% – 19.16%1||$5,000 - $100,000|
|7.98% – 35.99%||$1,000 - $50,000|
|7.99% – 35.97%*||$1,000 - $35,000|
|99.00% – 199.00%2||$500 - $4,000|
|5.99% – 24.99%3||$5,000 - $35,000|
|7.99% – 29.99%4||$7,500 - $40,000|
|7.99% – 20.88%5||$5,000 - $50,000|
|15.49% – 35.99%6||$2,000 - $25,000|
|10.68% – 35.89%7||$1,000 - $40,000|
|9.95% – 35.99%8||$2,000 - $35,000|
|1 Includes AutoPay discount. Important Disclosures for SoFi. |
2 Includes AutoPay discount. Important Disclosures for Opploans.
Direct Deposit required for payroll.
Opploans currently operates in these states: . *Approval may take longer if additional verification documents are requested. Not all loan requests are approved. Approval and loan terms vary based on credit determination and state law. Applications processed and approved before 7:30 p.m. ET Monday-Friday are typically funded the next business day.
3 Includes AutoPay discount. Important Disclosures for Payoff.
4 Important Disclosures for FreedomPlus.
5 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
6 Important Disclosures for LendingPoint.
7 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage and history. The APR ranges from 10.68% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 9.56% and a 5.00% origination fee of $300 for an APR of 13.11%. In this example, you will receive $5,700 and will make 36 monthly payments of $192.37. The total amount repayable will be $6,925.32. Your APR will be determined based on your credit at time of application. The origination fee ranges from 2% to 6% (average is 4.86% as of 7/1/2019 – 9/30/2019). In Georgia, the minimum loan amount is $3,025. In Massachusetts, the minimum loan amount is $6,001 if your APR is greater than 12%. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
8 Important Disclosures for Avant.
*If approved, the actual loan terms that a customer qualifies for may vary based on credit determination, state law, and other factors. Minimum loan amounts vary by state.
**Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33.
Based on the responses from 7,302 customers in a survey of 140,258 newly funded customers, conducted from August 1, 2018 – August 1, 2019, 95.11% of customers stated that they were either extremely satisfied or satisfied with Avant. 4/5 Customers would recommend us. Avant branded credit products are issued by WebBank, member FDIC.
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
Personal loans made through Upgrade feature APRs of 7.99%-35.97%. All personal loans have a 2.9% to 8% origination fee, which is deducted from the loan proceeds. Lowest rates require Autopay and paying off a portion of existing debt directly. For example, if you receive a $10,000 loan with a 36-month term and a 17.98% APR (which includes a 14.32% yearly interest rate and a 5% one-time origination fee), you would receive $9,500 in your account and would have a required monthly payment of $343.33. Over the life of the loan, your payments would total $12,359.97. The APR on your loan may be higher or lower and your loan offers may not have multiple term lengths available. Actual rate depends on credit score, credit usage history, loan term, and other factors. Late payments or subsequent charges and fees may increase the cost of your fixed rate loan. There is no fee or penalty for repaying a loan early. Accept your loan offer and your funds will be sent to your bank or designated account within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes the transaction. From the time of approval, funds should be available within four (4) business days. Funds sent directly to pay off your creditors may take up to 2 weeks to clear, depending on the creditor. Personal loans issued by Upgrade’s lending partners. Information on Upgrade’s lending partners can be found at https://www.upgrade.com/lending-partners/.