What helps credit score more: Pay debt all at once? Or in bits?
Let's Talk Credit
Dear Let's Talk Credit,
If I have enough money to pay off a credit card with a $5,000
balance, is it still better to pay it off over time, say with large payments,
than it is to just pay it down all at once? I would not be closing it, just
paying it off. I have made all the payments on time. -- Mary
If you are concerned about maintaining a strong credit score,
in most cases, paying the entire balance off at once would likely help to
improve your score. The reason is because your credit available to credit used ratio is a factor in your score. Paying off the balance would leave you with a 0-percent ratio on that one card. Your goal for the best credit score is to have
ratios below 30 percent.
In addition to lowering your credit availability ratio, you also
want to show that you can make on time credit payments. (That's because payment
history is 35 percent of your FICO credit score.) If you decide to pay off your
credit card account, and you do not have very many accounts on your credit
report and/or you don't have any installment accounts, you might consider
occasionally charging something that you normally purchase, such as groceries, and then paying it off at the end of the month to demonstrate your ability to pay on time.
If you have other credit cards with higher balances or interest
rates, you might think about doing a little math to determine how best to use
the money. For example, if you are currently paying 12 percent interest on a
$5,000 balance, and paying the typical minimum charge, you are paying about $50 per month in interest charges. If you
have another card with a balance of $3,000 at an interest rate of 29 percent,
you are paying $72.50 per month in interest charges. A credit card payments calculator will let you plug in your own numbers to see how it affects you.
One last thing I would like you to consider is whether or not
you have any money put aside for emergencies. If you don't have any emergency
savings, you might consider setting up a "rainy day" fund using half of the money you were considering putting toward your credit card debt. If you use all of your cash to pay off your balance and you don't have an emergency fund, you may have
no other choice but to use a credit card to pay any unexpected expense in the future.
See related: FICO's 5 factors: The components of your credit score
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Published: February 6, 2014