If you’re planning to buy a new car, hold off on applying for a personal loan to pay off credit card debt. It will ding your credit score on two fronts
Dear Credit Guy,
I have excellent credit, I owe about $11,000 in credit card debt, and I want to buy a new car. I want to pay off my credit card debt, I think with a personal loan. Is it better to get the personal loan to pay off my credit card debt before or after I purchase a new car? Thank you! – Celeste
Congratulations on your excellent credit score. Knowing what might affect your score is probably one of the reasons you have achieved that mark, so you also deserve extra kudos for being proactive when it comes to actions that affect that score.
One of those actions that can, at least temporarily, bring your score down is taking on a new loan. Even though what you are doing is basically trading one debt for another by getting a personal loan to pay off your credit card debt, your credit score will be slower to recognize that. Instead, your score will take a hit for both a hard inquiry and a new account.
Even though your plan is to immediately pay off that credit card debt as soon as you receive the funds from the personal loan, those actions will take longer than taking on the new loan to show up in your reports and on your subsequent score.
It is true that in the long run these actions will probably cancel each other out, and your score will likely revert to where it was. In fact, once you have used the loan to pay off your credit card debt, you might find your score has increased a bit. But this takes time, probably several months at least.
The real question is how soon you are planning to buy a new car. It sounds as if this is something you want to do in the near future. If that is the case, you should hold off on the personal loan until you have secured your financing for the new car.
Keep paid-off credit cards open
One word of caution regarding those credit card accounts: Once the accounts are paid off, you should not close the accounts, unless they have prohibitive annual fees. Closing accounts will negatively affect your score for several reasons.
- You have an excellent credit score, which implies that you have been responsible with your credit card accounts by paying them on time and keeping them well below your credit limits.
- In addition to your payment history, the actual age of your accounts is important in the credit scoring model. You will lose those pieces if you close the accounts.
I would suggest you continue to use the credit cards in a way that will benefit you. Use your cards to pay for expenses that you already planned for, and which you can pay for in full each month. Groceries and gas are two expenses that work well with this tactic.
Using your cards in this way will keep your accounts active, and you will never pay another cent in interest because you will pay off the accounts each month. Both are good for your credit score and for your overall financial health.
Take care of your credit!