Q: I have 4 credit cards: The first has a $5,459 balance (out of a $6,000 credit limit) at 7.9 percent.
The second card has a $5,433 balance ($6,200 credit limit) at 5.99 percent.
The third card has an $8,200 balance (out of a $9,000 credit limit) at 0 percent interest until the end of October. The fourth card has a $5,039 balance (out of a $6,000 credit limit) at 3.99 percent.
With my balances so close to my credit limits, my credit score is suffering. Right now, I have $5,000 saved to pay off some cards. Should I pay off one card or should I use the money to decrease some of my balances so my balance/limit ratio decreases? Do you have any other suggestions?
A: Paying off your cards will help your credit score, but since you can’t pay off all of your cards at once, you’ll need to be strategic in how you allocate your cash.
If you want to improve your credit score, you’re best off paying down your balances so that you have as low a balance-to-credit-limit ratio as possible. In your case, you should pay down cards #1, #2, and #4 by $1,500 each. That will be a total of $4,500. I’d put the final $500 toward card #1, since that card has the highest interest rate.
Your balances on each of those cards will still be slightly more than 50 percent of your credit limit, but because the percentage of debt-to-credit limit will decrease, it will help your score. You should continue making the same monthly payments on each of those accounts (to help pay them down faster) and then throw any available cash toward card balance #3, even though you aren’t paying any interest on that account.
If you’re looking to pay off the cards the fastest (which will also improve your credit score), then use your $5,000 to nearly pay off Card #1. You’ll have just a $459 balance, which you should be able to eliminate in about one to two more months.
Then, take all of the money you were putting toward paying off that balance (plus your savings) and start paying down Card #2. Hopefully, you’ll be able to pay off that card in less than 6 months. When that’s finished, you’ll need to take the extra cash you were spending (everything from Card #1 and Card #2) and divide the amount equally between Cards #3 and #4.
The good news is that if you’ve been able to save $5,000, you have extra cash in your budget to make a huge, fast dent in these payments. As long as you’ve stopped charging on these (and any other) accounts, you should be able to pay off all of your cards within a year to 18 months.
And that will dramatically improve your credit score.
An additional thing to keep in mind, if your credit score takes a big hit, some credit card companies have been known to change their terms on their cards and increase the interest rate on the outstanding balances in response. That change, which is known as “universal default” can hit you hard.
And finally, you should consider the low interest rate you have on each of the cards and calculate how long you have until the interest rates go up. If you’ll still have a balance to pay on the card when the interest rate is scheduled to rise, you might want to pay down a greater amount on those cards that will lose the benefit of the lower interest rate earlier.