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How to Organize Your Debt Payments

Posted on August 30, 2010

Credit repair and getting out of debt go hand-in-hand. After all, your level of debt affects 30% of your credit score. The higher your credit card balances are compared to their credit limits, the more your credit score will be hurt. Similarly, when your loan balances are high compared to the original loan amount, your credit score takes a hit. This ratio of debt to credit limit (or loan amount) is known as credit utilization or how much of your available credit is being used.

While paying down debt will repair your credit score, you must make sure you’re paying off debts in the right order. Otherwise, you’ll be lowering your debt, but your credit score could go up only a little.

Pay Off Credit Cards Based on Credit Utilization

To figure out which debts you need to pay off first, it helps to consider how your credit score looks at your level of debt. Since higher credit utilizations hurt your credit score most, you should focus on lowering your credit card balances for all credit utilizations over 30%.

Figure out the credit utilization for each of your credit cards. To do this, divide your credit card balance by your credit limit. For example, if you have a credit card with a $500 limit and a $300 balance you would do this calculation 300 / 500 = 0.6 or 60% credit utilization. Let’s say you also have a credit card with a $600 balance and a $1,500 credit limit, the credit utilization for that credit card is 40%.

If you were focused on paying off the two credit cards above, you might start with the $600 credit card balance because it’s the highest. However, that credit card has the lowest credit utilization. It would be most helpful to pay down the $300 balance to at least $150, then the $600 to at least $450. That would bring your credit utilization for both cards to 30% for each credit card. After that point, you can work on paying off whichever credit card you choose.

What About Loans?

While high loan balances do affect your credit score, they don’t have as severe of an impact on your credit score as credit card balances. If you have both credit card and loan debt, focus on bringing down your credit card balances first. Then, you can continue repairing your credit by paying on your loans.

Always Keep Up With Minimum Payments

It’s better to make lump sum payments on a single debt than to spread your higher payments among all your debts. In other words, you should put your extra $150 toward a single debt instead of paying an extra $25 to this debt, $50 to that debt, and $75 to another debt. You’ll get rid of debts faster by paying lump sums on your debts.

Even though you’re paying a lump sum on one debt, you should continue making minimum payments on all your other debts. Missing your minimum payment will hurt your credit score and set back your credit repair progress.

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