Improving your credit score can help you get approved for loans and credit cards at lower interest rates. Paying off your debt can be an effective way of improving your credit score. However, not all debt payments will have the same effect on your credit score.
Credit Utilization Ratio
One of the factors that makes up your credit score is the credit utilization ratio. This is a comparison of the amount of debt you have accumulated in relation to the available credit you have. For example, if you have $1,000 in debt on a credit card with a $10,000 credit limit, you have a 10 percent credit utilization ratio. The credit scoring formulas consider your credit utilization ratio when calculating your credit score. The lower the credit utilization, the more it helps your score.
Paying Down Balances
When paying off your debts, making regular payments is important. Late payments hurt your credit score significantly. Once you get the balances on your accounts down to around 30 percent of their credit limit, this will boost your score. According to Bankrate, a credit utilization under 30 to 35 percent is a solid credit utilization ratio. Aiming for 25 percent or lower makes it appear you know how to handle your money. People who frequently max out credit cards (a 100 percent credit utilization ratio) tend to get into financial trouble.
Closing Accounts
If you pay off credit accounts, resist the temptation to close out your account, if possible. Consider paying off the balance and leaving the account open. When you close out an account, this lowers the amount of available credit you have. This, in turn, would raise your overall credit utilization ratio and lower your credit score. If you close out the account that has been open the longest, this also will negatively affect your credit score, because the length of time you have held your credit accounts is also a factor in credit scoring. Accounts open for a long time help your credit score more than new accounts.
Considerations
When you have several accounts, pay attention to the credit utilization ratio on each card. If you have money available to pay down a balance, choose the one that is closest to the 30 percent threshold. Pay down the balances systematically so they get below that threshold, and it will slowly raise your credit score. Once you pay off the account, leave it open so you can maintain a low credit utilization ratio and a longer credit history, both of which help your credit score. Make payments to all creditors by the due date. Your payment history is the biggest factor in determining your credit score.
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