In today’s age, it’s almost inevitable not to incur debt in order to accomplish big life goals, such as paying for college, buying a new house, getting married, etc. How to pay off those debts effectively without hurting your credit score can sometimes be a challenging task to undertake. Guest writer, Lidia Staron highlights a few key points to consider when deciding this major life topic.
Can I Pay Off Debt Without Hurting My Credit?
Is it possible to pay off your debt without hurting your credit score?
The question is “how”?
Becoming debt-free is most people’s financial goal. Wouldn’t it be great to enjoy your paycheck in full? Save it for your dream vacation, investment, new purchases, and so much more? Wouldn’t it be great if you will have full control of your money?
While we all want to be debt-free, loans are inevitably helpful in our lives. If you’re using it to finance your family home, support your studies, or repair your house, incurring debts is absolutely okay.
The challenge, however, is paying it off.
Technically, paying your loan balances is better for your credit score. But how you handle debt also has an impact on your credit score.
Here are the most common questions people ask about debt management and its impact on their credit scores:
Which debt should you prioritize paying?
When you need to decide whether to pay off a credit card first or an installment loan, which will you choose? It is important to understand the different types of loan and which one has a greater impact on your credit score. Generally, there are two types of loan: revolving and installment. Revolving loan, such as a credit card loan, is a line of credit that can be used again whereas installment loans, for instance personal loans and car loans, meant to be used once and paid off. In terms of impact, revolving loans tend to put a heavier toll on your credit score.
Verdict: Whenever possible, prioritize paying off revolving loans over installments as it has a positive effect on your credit utilization ratio.
Is it fine to pay just the minimum on credit card loans?
Your credit card issuer only asks you to pay the minimum amount due each month. When you don’t have enough cash to settle the entire loan, paying the minimum might be your only option. However, this has a negative effect on your credit rating. Take note that your credit score involves your credit utilization or how your credit is being used. The more you use up your credit limit, the lower your score gets.
Verdict: If you’re just paying the minimum and you make additional purchases using your credit card, your credit rating will suffer as your total loan simply gets bigger.
Can you consolidate loans?
Debt consolidation is a debt relief strategy that also has an impact on your finances. When used incorrectly, it can hurt your credit score too. Consider choosing debt management as your consolidation option as it will not harm your credit rating. However, it will indicate that you’re enrolled in a debt management program, and your credit accounts will be frozen. You will also not be able to open new credit accounts until you’ve paid off your loan. Look for a reliable debt consolidation company and commit to making on-time payments.
Verdict: Debt consolidation is a debt relief strategy that helps you pay off your debt. However, make sure to pay on time and you can afford to pay your credit card balance.
Do you want to boost your credit score?
Once you’ve paid off your debt, you might be encouraged to close your credit card accounts to be entirely free from loans. While this sounds like a great idea, it actually isn’t. In fact, it can create a red flag on your rating. Why? Because part of your FICO credit score computation is based on how long your accounts have been open.
Verdict: Wait for a few months before closing one credit card account. It is also important to leave a couple to build and maintain your credit score.
Should you file for bankruptcy?
Bankruptcy will also hurt your credit score. Worse, they stay on your credit report for years. For instance, filing for Chapter 7 bankruptcy stays on your report for 10 years while filing for Chapter 13 stays for 7 years, even if you already completed the repayment plan.
Verdict: Avoid bankruptcy as it has no positive impact on your credit score.
Getting out of debt without hurting your credit score is possible. But to do this, you have to plan carefully and execute that plan. You must also make necessary adjustments to your budget so you don’t overspend and ensure that you have enough money to pay your monthly dues on time. Also, learn which debts to prioritize. If considering a debt relief strategy, study the program carefully and make sure that you are able to strictly comply with its terms. Lastly, don’t rush into closing your credit card accounts. Keeping a couple helps build and maintain your credit score.
Lidia Staron has been working as a writer, editor and literary coach for 5 years. She contributes articles about the role of finance in the strategic planning and decision-making process. You can find really professional insights in her writings.