In today’s article, we’ll discuss which card to pay off first, how credit cards affect your credit score, and how to rebuild your credit score fast.
How Does Credit Card Debt Work?
In the world of credit reports, credit cards are what is known as “revolving debt.” This means the account is constantly open and available so long as you make monthly payments and don’t max out the card.
Home and auto loans, on the other hand, are what are known as “installment loans.” This basically means that you know in advance what your monthly payment will be and how long the loan will last. Once your loan is paid, the account is considered closed.
The way credit cards add interest to your debt can be quite confusing. You may see the term APR on your credit card statement–APR stands for ‘Annual Percentage Rate,’ and is the amount of interest you’ll owe each year. However, credit card companies don’t add interest charges to your account annually, they add interest monthly. This is done by dividing your APR by twelve (twelve months in a year).
Let’s make this very simple and say that you have an APR of 12%. This means each month the credit card company will add 1% to your outstanding balance. If you owed them $100 at the start of the month, at the start of the next month you’ll owe them $101.
There are typically at least two types of credit card debt—everyday purchases and cash advances. Everyday purchases are charged your normal APR interest rate, and cash advances are often charged at much higher rates, sometimes even double or triple the amount. Each month, these interest rates are calculated separately and added together to make up your current balance and amount due.
Which to Pay off First
Well, first let’s make it clear that we aren’t talking about making a payment on one card and completely ignoring a payment on another card. That’s a quick path to ruining your credit score.
We’re talking about large payments on your credit card debt–perhaps you got a Christmas bonus and want to make a dent in your debt, or you’re wondering if paying off collections improves credit scores.
The best way to approach this is to attempt to pay off the highest interest rate cards first, along with the cards that have the highest balance from any cash advances you may have. By paying off the high-interest rate cards first, you can save yourself hundreds or even thousands of dollars in interest payments.
How Credit Cards Affect Credit Scores
So long as you make your payments on time and don’t max out your credit limits, having an open credit card on your credit report is typically a good thing. It shows the credit reporting bureaus that you’re managing your debt responsibly.
However, should you miss a payment or start to reach the top of your credit limit, you may see your score go down.
Other things that can negatively affect your credit score are accounts that have gone to collections, missed payments on a home or auto loan, and Chapter 7—for more information, read our article on how to know when your Chapter 13 is over.
That being said, credit reports aren’t flawless–there are often inaccuracies that may be negatively affecting your credit score. This is where a credit repair agency like The Phenix Group comes in. We can work to remove these inaccuracies so you can focus on what really matters most.