Q: I have a lot of debt through credit cards and lines of credit. I can finally start paying more than the minimum. All interest rates are about the same. Should I pay a little extra toward each debt, or pay a lot extra toward one or two debts?
A: Good question. When you have debt on a lot of different cards, and the interest rate is different, you always should first pay off the non-deductible debt (debt other than a mortgage or home equity loan) that carries the highest interest rate.
When all interest rates are the same, you should then look to which cards carry the highest percentage of your available credit.
For example, let’s say you have two credit cards, and each allow you a maximum available limit of $5,000. On Card A you’ve charged $3,500 and on Card B you’ve charged $4,000.
While the interest rate on both is the same, your credit history gets dinged by the fact that you’ve charged more than 30 to 40 percent of the available credit line on both of these cards. On Card A, you’ve charged 70 percent of your available limit and on Card B, you’ve charged 80 percent of your available credit limit.
Carrying that much debt on a card is a big negative for credit reporting bureaus, and your credit score will go down as a result.
So all else being equal, start paying down the card where you have charged the highest percentage of the available credit limit. In my example, you’d throw almost everything you have at Card B, until you bring it down to about 40 percent of the available credit limit. Then, start prepaying Card A. Remember, you will still need to make the minimum payments due on any of your debts before paying down any other card.
If you can, you may want to take a short-term part-time job and devote all of the income from that job toward prepaying your credit card debt.
Once the debts are paid off, don’t close the accounts unless you have other credit card accounts you’ve maintained for many years. Your credit history will get dinged if you close long-standing accounts and open up new ones because it looks like you can’t manage your financial life.
For more information about your credit history and credit score, log onto myFICO.com, which is a joint venture between Equifax (one of the three major credit reporting bureaus) and Fair Isaacs, the company that invented the FICO credit score.