Chris Scott
Contributing Writer at Tally
November 6, 2020
Having a good credit score creates numerous financial opportunities, providing access to the best rates from lenders. However, if you have significant credit card debt, you might have a poor credit score.
So, how much will paying off credit cards improve your score?
In this article, we answer that question and more. We’ll break down what you can do to improve your credit score and how much of an improvement you can expect to see. Get ready to start crafting a plan so you can embark on your road to financial freedom.
What is a credit score?
A credit score is a three-digit number that measures your creditworthiness. More specifically, it’s a predictor to determine the likelihood that you will fall at least 90 days behind on a bill within the next two years.
Lenders use your credit score to determine how likely you are to repay the money you borrow. Credit scores are based on information in your credit report, including:
Payment history
Your outstanding debt and credit card balances
Length of credit history
Your credit utilization ratio, a measure of how much revolving credit you use compared to your total credit limit
The number of accounts you have open
How often you attempt to open new accounts
Whether you make on-time payments
Your credit mix, or the types of credit that you have (it’s beneficial to have a combination of different credit types, such as student loans and credit cards)
Higher credit scores indicate that you manage your personal finances well and are responsible with your money. Lower scores are a cause of concern for lenders and make it difficult to secure funding. Having a low credit score also disqualifies you from receiving the best interest rates, costing you more in long-term interest.
How much will paying off credit cards improve your score?
To answer this question, you must first understand your credit limit. Each card issuer gives you a credit limit, or a maximum amount you're allowed to charge on a card. The closer you are to your credit limit, the more paying off credit cards improves your score because it reduces your credit utilization rate.
Similarly, the more you pay down on your balance, the more you impact your credit score. For instance, if you pay your balance in full, your credit utilization drops, and your score improves dramatically.
If you pay off your credit card incrementally, you’ll also improve your score. But you won't see as big of a jump compared to paying it in full. Credit scores reflect your incremental progress, so your score will improve gradually over time.
Credit bureaus consider both per-card and overall utilization rates, so the same rules apply if you have multiple credit cards. Paying off one balance in full can improve your credit score more quickly than if you slowly pay off each card over time.
There's no way to define how many points your score improves by when paying off credit cards. If you have bad credit, a few fixes and timely payments can do wonders for your credit score. Those with bad credit scores can see an increase in 40 points in as little as six months by practicing fiscal responsibility.
On the other hand, if you're already in good standing with your credit card company and don't carry monthly balances, continuing to do so won't affect your score that much.
Why does credit card debt impact credit scores more than other lending options?
Credit card debt is incredibly risky. Credit card accounts typically have APRs that are significantly higher than car loans or personal loans. Credit cards also have compounding interest, which means that your interest charge is based on your total balance, including the principal and any interest accumulated to date.
This is different than a fixed payment lending option like a student loan, where you know exactly how much you need to pay each month and the interest does not compound on itself.
As soon as you begin carrying a balance on your credit card, your interest increases, therefore increasing your debt. Your credit utilization increases as well. And as you accumulate debt, it becomes harder and harder to pay your balance, which means the debt has a greater and greater impact on your credit score.
You may find yourself missing minimum monthly payments. If you makelate payments, your credit card company charges you penalty APRs, which means you’ll accrue even more in interest. These late payments make their way to your credit profile, showing up on your credit report and harming your score.
Keeping a low balance on your credit accounts is one of the best ways to ensure you have the best credit possible.
Are all credit scores the same?
No, there are two different types of credit scoring models — the VantageScore and the FICO score. The three major credit bureaus — Equifax, Experian, and TransUnion — use both of these scores.
The VantageScore has a score range between 300 to 850, with 700 being considered good credit. The FICO Score also ranges from 300 to 850, with 670 being considered a good score. There are also industry-specific FICO scores available for things like auto loans.
Both VantageScores and FICO credit scores use factors like payment history and credit usage. Each has their own formula for rating different criteria. If you practice fiscal responsibility, you'll have a high score with both models. It’s worth noting that 90% of lenders use FICO scores.
Should you pay off your credit cards in full or maintain a balance?
There’s a prevailing myth that paying off your balance in full is a mistake when trying to build credit. However, this is just a myth. Whenever possible, pay down your credit card balances in full and on time. If you can't do this, make timely minimum payments at the very least.
If you must carry a balance, keep your credit utilization rate in mind. Keeping your credit utilization below 30% is an important factor for your credit score. VantageScore considers credit utilization to be highly influential, while FICO says it accounts for 30% of your score.
Let's say that you have $10,000 in available credit. To ensure that your credit utilization is not higher than 30%, you should carry less than $3,000 in balances.
What methods can you use to pay off credit cards?
If you want to get on the road to excellent credit, two strategies work particularly well: balance transfer cards or a credit card payoff app.
Balance transfer cards
The first is to use a balance transfer credit card. This type of credit card allows you to transfer your outstanding balances from other credit cards onto a single card. Balance transfer cards typically offer an introductory APR of 0% for a certain period of time, often 12-18 months.
There is a balance transfer fee when using the card, typically 3% to 5% of the total amount you transfer onto the card. However, if the fee is lower than the APR on your current credit cards, it could be worthwhile to open this new credit card and pay down debt without any interest charges.
Tally, the credit card payoff app
The other option is to use a credit card payoff app like Tally. With Tally, you no longer need to worry about tracking billing cycles and minimum payments. You make one payment to Tally each month. Tally pays off your credit cards in the most efficient way possible, helping you pay down debt and save money on interest.
However, both of these strategies require you to have good credit. If you don’t have good credit, you’ll want to look at either the debt avalanche or debt snowball methods.
Under the debt avalanche method, you pay off your highest APR credit cards first. When doing so, you'll continue to make minimum payments on your other credit cards. By doing this, you reduce your long-term interest charges. Once you pay off one card, you put your funds toward paying off the card with the second-highest APR.
Another option for paying off credit card debt is the debt snowball method, which calls for you to pay off your credit cards in order from the smallest balance to largest. Once you pay off your smallest debt, you move to the card with the second-highest balance, saving the card with the highest balance for last. Although you’ll pay more in long-term interest, you’ll quickly cut down on the number of delinquent cards while gaining a few quick wins.
Start paying down debt today
How much will paying off credit cards improve your score? The short answer is that it depends on your current situation. The worse your credit, the more paying off cards has an impact. If your credit is good, continuing to pay monthly balances holds it steady or gradually improves it, ensuring that you still have access to prime lending options and the best interest rates.
If you're looking for help paying down credit cards, try using a balance transfer card or Tally. Both can help you get started paying down debt and improve your credit score in the process. If you aren’t eligible for these options, consider instead using the debt avalanche or debt snowball methods to gain momentum and pay off your credit cards.
As an enthusiast deeply immersed in the realm of personal finance and credit management, I can confidently affirm that having a good credit score is a cornerstone for unlocking a plethora of financial opportunities. My expertise extends to understanding the intricate dynamics of credit scoring systems and the profound impact that credit card debt can have on one's creditworthiness.
The article you presented, authored by Chris Scott, delves into the crucial connection between credit card debt and credit scores. Allow me to break down and elaborate on the key concepts covered in the article:
Credit Score Basics:
A credit score is a three-digit number that assesses creditworthiness, predicting the likelihood of falling behind on bills within the next two years. Lenders use various factors to determine this score, including:
- Payment history
- Outstanding debt and credit card balances
- Length of credit history
- Credit utilization ratio
- Number of open accounts
- New account openings
- On-time payments
- Credit mix
Higher credit scores indicate responsible financial management, while lower scores pose challenges in securing funding and obtaining favorable interest rates.
Impact of Paying Off Credit Cards:
The article emphasizes that paying off credit cards can significantly improve your credit score. Credit utilization ratio plays a pivotal role—the closer you are to your credit limit, the more your score improves when reducing balances. Clearing the balance entirely or paying it down incrementally both contribute to score improvement, with a faster impact when paying in full.
Credit Card Debt vs. Other Lending Options:
Credit card debt is highlighted as particularly risky due to higher APRs and compounding interest. Unlike fixed-payment loans, credit cards' interest compounds on the total balance, making it challenging to manage and negatively impacting credit scores with missed payments.
Types of Credit Scores:
The article mentions two primary credit scoring models—VantageScore and FICO score. Both use factors like payment history and credit usage, but they have different score ranges and criteria. While VantageScore ranges from 300 to 850, with 700 considered good, FICO Score also ranges from 300 to 850, with 670 being a good score. The majority of lenders use FICO scores.
Paying Off Credit Cards Myth:
The article dispels the myth that paying off credit card balances in full is detrimental to building credit. It advocates for paying balances in full and on time whenever possible. Credit utilization below 30% is crucial for a positive credit score, according to both VantageScore and FICO.
Strategies for Paying Off Credit Cards:
Two effective strategies mentioned are:
- Balance Transfer Cards: These cards allow transferring balances to a single card with a 0% introductory APR for a specified period, helping pay down debt without interest.
- Credit Card Payoff App (e.g., Tally): Automates payments efficiently, helping pay down debt and save on interest.
The article also touches on debt avalanche and debt snowball methods for those with lower credit scores.
In conclusion, the knowledge shared in this article provides valuable insights into the complex interplay between credit card debt and credit scores, offering practical strategies to improve financial health and achieve a higher credit standing.
