If you know anything about
credit scores, you know carrying high credit card balances is a big no-no. In
fact, your debt-to-credit ratio (how much you owe versus your total available
credit) makes up about 30 percent of your overall credit score. And revolving
debt – like credit cards – weighs heavier than other outstanding
debts – like your mortgage or car loan. So if you’re carrying a bunch
of maxed-out credit cards, your credit score is likely in the tank.
The
most straightforward way to improve your debt-to-credit ratio is to simply pay
down those balances. But chances are if you’re in a lot of debt, you can’t pay
off all the balances right away. (That’s how you got here in the first place,
right?)
Here’s
the good news: You don’t have to pay your credit cards off to boost your credit
score. But to get the most credit score traction out of every extra payment,
you do need to come up with a plan for paying
down your credit cards in a
certain way.
The
snowball method
The
snowball method is excellent for paying off debt quickly and efficiently.
Basically, you throw extra money at one debt, and when it’s paid off, put the
extra plus the old debt’s minimum payment toward
the next debt. Repeat this until you’re debt-free.
This
is an excellent way to get out of debt, if just getting out of debt is your
goal. But what if your goal is to get out of debt while also boosting your
credit score as quickly as possible? Maybe you’re hoping to apply for a
mortgage soon, or a car loan?
In
this case, the snowball method probably isn’t how you want to start.
Eventually, you might switch to that, but you may want to begin by evening out
your credit card balances.
Lowering
your debt-to-credit ratio
When
FICO calculates your credit score,
it looks at not only your overall debt-to-credit ratio, but also the individual
debt-to-credit ratios of your various credit cards and other revolving debt
accounts.
Here’s
an example:
Card 1:
$5,000 balance/$10,000 limit = 50 percent debt-to-credit ratio
Card 2:
$4,500 balance/$5,000 limit = 90 percent debt-to-credit ratio
Card 3: $500
balance/$1,500 limit = 33 percent debt-to-credit ratio
Overall:
$10,000 balance/$16,500 = 60 percent debt-to-credit ratio
In
this case, your overall 60 percent debt-to-credit ratio will ding your credit
score pretty severely. A “good” debt-to-credit ratio is around 30 percent, and
you’re nearly doubling that.
But
since your score also accounts for individual credit cards, you can see that
Card 2 is hurting you the worst – it’s nearly maxed out, which is not good. Card 3 is posing the smallest
problem, since it is nearly in that “good” range.
In a
situation like this, you’ll boost your credit score if you focus on paying down
Card 2 first. Depending on the interest rates of each of these cards, you might
choose to pay that card down all the way.
Or if
it’s a card with a lower APR, consider throwing money at its balance until it’s
at or near $1,500 to reach the 30 percent debt-to-credit ratio. Then move on to
Card 1 or whichever card has the highest interest rate.
Now,
this strategy isn’t guaranteed to add hundreds of points to your credit score.
But because you’re improving individual debt-to-credit ratios for each of your
credit cards, you will make progress more quickly than if you just snowballed
your debt.
Still,
you need to marry this with some aspects of the debt snowball, including the
intensity with which you pay down your debt. After all, the only way to try to achieve credit score perfection is to pay your credit cards off
completely, and refuse to carry a balance again.
Why
not just spread it around?
Maybe
you’re reading this thinking, “Why not just transfer some of the balance from
Card 2 to Card 3? Or get another credit card to transfer some of that balance?”
You
could. In fact, moving balances to 0
percent APR balance transfer cards can
be a good strategy for both boosting your credit score and getting out of debt.
But just shifting your balances around isn’t going to help much here, partially
because the credit limit on Card 3 is so low to begin with.
What
if you do have a $0 balance card in the mix? In this case, you still don’t want
to transfer another card’s balance. This is because one part of your credit
utilization mix is the number of accounts that carry a balance. So having three
accounts carrying a balance and one with no balance is better than having four
accounts carrying a balance – even if that move improves one card’s
debt-to-credit ratio.
You
can’t game the system
The
bottom line here is that credit scoring models are so sophisticated these days
that you can’t really “game the system” by shifting debt from one card to
another. In the long run, you just need to focus on getting those credit card
balances paid off.
In the
meantime, bringing cards below a 30 percent (or even 50 percent) debt-to-credit
ratio may boost your credit score more quickly than simply snow balling your
debt. This is especially true if your debt snowball would leave a maxed-out
credit card in the mix for months to come.