When it comes to personal finance, there are few topics that are discussed more often than credit scores. It doesn’t seem like a simple three-digit number would have that much impact on how you manage your money, but your score shapes whether you’re able to make a big purchase or qualify for the best rates on loans.
Carrying around a boatload of debt doesn’t do much to improve your score, but the way you pay it off could also have an adverse affect. If you’re trying to dig your way out from under high-interest credit cards, student loans or a car loan, taking steps to protect your credit score in the process is vital.
Pay debts in the proper order
Not all credit is created equally and one of the things that impacts your score is the mix of different credit types you owe. Revolving credit is a line of credit that can be used again, such as a credit card while an installment loan, such as a car loan or student loan, is meant to be used once and paid off. In terms of the impact each type of credit has on your score, revolving credit tends to weigh a little more heavily.
When you’ve got a choice between paying off a credit card or two and tackling an installment loan, you’re better off wiping out the revolving debt first. The reason? It has a more positive impact on your credit utilization ratio, which is the amount you owe compared to the total amount of credit you have.
When you pay down a revolving account, you have the option of leaving it open once the balance reaches zero. With an installment loan, the account is effectively closed once you’ve paid it off. Paying off the revolving accounts first positively improves your utilization ratio which can boost your score, whereas eliminating the installment loan first does neither and in some cases, can actually cause your score to drop.
Don’t rush to close accounts
Once you’ve paid off a credit card or other revolving account, you may be tempted to close it right away to avoid racking up any additional charges but you shouldn’t be so quick to pull the trigger. Approximately 15 percent of your FICO credit score is based on how long your accounts have been open and the longer your account history, the higher your number will be.