Credit Score: Know which debts to pay off first for a healthy credit report
15 October, 2024 | 17:00 IST
Managing debt and improving your credit score can feel like a balancing act, but knowing which debts to pay off first can improve your financial health. A strong credit score is crucial for obtaining loans, credit cards and other credit instruments. The key to credit score improvement lies in strategic debt management.
But, where should you begin? Let’s take a look at the most effective way to pay off debts to boost your credit score.
A credit score is a numerical representation of your creditworthiness, usually ranging between 300 and 900. Lenders consider you a trustworthy borrower if your credit score is on the higher side. A credit score above 750 is generally considered excellent and gives you access to the best credit products. Anything between 600 and 750 is considered fair, but if your credit score drops below 600, you may struggle to secure new personal loans or credit cards.
Several important factors like payment history, credit utilisation, length of credit history, types of credit instruments you hold and recent credit inquiries, among others can significantly affect your credit score.
If you’re wondering how to boost your score, it’s essential to focus on paying off the right debts first. Users can check their credit score instantly for free on the Moneycontrol app.
Which debts to pay off first to improve credit score?
When deciding which debts to pay off first, several factors come into play, including overdue payments, interest rates and the type of debt.
Here are a few easy tips to help you prioritise your loan payments for the credit score improvement:
Start with overdue debts: If any of your accounts are delinquent or in collections, paying them off should be your top priority. Delinquent debts can cause a massive dip in your credit score and may even lead to legal action or seizure of assets. Clearing these accounts first will prevent further damage to your credit history. While it won’t instantly restore your credit score, minimising overdue accounts will gradually improve your creditworthiness.
Clear credit card debts: Credit cards carry higher interest rates than most other forms of debt, and they are classified as revolving debt, meaning they don’t have a fixed payment term. High credit utilisation — using a large percentage of your available credit — can negatively impact your credit score. If your credit card debt is near its limit, aim to bring it down to less than 30% of your total credit limit. For example, if your credit card limit is ₹1 lakh, try to keep your balance below ₹30,000. Reducing your credit utilisation to below 30% will have a noticeable impact on your credit score.
Pay off debts with the highest interest rates: In addition to credit cards, you may have other high-interest debts, such as personal loans. These debts can become costly over time due to accumulating interest, and paying them off first will save you money in the long run. Start by listing all your debts and their interest rates, and then first target to clear the debts with higher interest rates. This approach helps in both reducing your overall debt burden while improving credit score.
Focus on credit cards with low limits: If you have multiple credit cards, focus on those with lower limits. Paying off the outstanding dues on these cards will help reduce your overall credit utilisation ratio, which is one of the key factors in credit score improvement. Moreover, if you decide to close the card after paying it off, your overall debt outstanding decreases, helping your credit profile.
Pay off your student loans, if any: Student loans are usually classified as instalment loans, meaning they have fixed monthly payments over a set period. Paying off your student loans, if any, can improve your debt-to-income ratio, but it may not dramatically impact your credit score. Also, lenders prefer to see a mix of different types of credit, such as instalment loans (student loans, home loans) and revolving credit (credit cards). So, while paying off student loans is a good financial move, focus on reducing revolving debt for quick credit score improvement.
Reduce small balances on multiple credit cards: The small dues across multiple credit cards can also hurt your credit score. Credit scoring agencies often look at how many cards carry a balance, so paying off these small balances can give your score a small, but helpful, boost. Consider clearing these small balances to simplify your finances and eliminate the burden of managing multiple accounts.
Pay off long overdue bills: If you have long-overdue bills, it’s never too late to start paying them off. Prioritise the most recent past-due bills first, as these could have the most significant impact on your credit score. Though catching up on overdue bills won’t remove the record from your credit report immediately, it shows lenders that you are making an effort to repay what you owe. This will improve your creditworthiness in the long term.
Once you have a debt repayment strategy in place, you need to track your progress. Constantly monitoring your credit score will help you stay updated on how your debt payments are affecting your score.
Check your credit score regularly: Keeping track of credit score is the first step in improving it. Use the Moneycontrol app to get a free credit score and detailed credit report.
Track your credit utilisation: Keep a close eye on your credit card balances and make sure they don’t exceed 30% of your total credit limit.
Avoid new debt: Applying for new credit or loans can lower your score due to hard inquiries on your credit report. Focus on repaying existing debts before taking on new liabilities.
Set up payment reminders: Missing payments will negatively impact your credit score. Setting up reminders or automatic payments can ensure you don’t miss due dates.
Overall, improving your credit score isn’t about paying off all your debts at once but rather strategically paying down the right debts. By focusing on the above-mentioned factors, you can steadily work your way towards a better financial health.
Remember, you can track your progress by regularly checking your credit score for free on the Moneycontrol app. Whether you’re looking to improve your credit score or just stay on top of your financial situation, Moneycontrol provides the tools and insights you need.
Summary
Managing debt effectively can maintain and even boost your credit score. Learn more about debt-management strategies you can adopt to enhance your creditworthiness.
Disclaimer
This piece/article was written by an external partner and does not reflect the work of Moneycontrol's editorial team. It may include references to products and services offered by Moneycontrol.
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