THE BLOG
08/01/2012 05:40 pm ET

What Should I Pay Down First?

Recently, I had a client in the office who was facing a situation that I've seen many times in the past. She wanted to improve her credit score. She had several accounts (which I'll list below) but not enough money to pay them all down right now. So she wanted to know which things would help her FICO score the most in order.

I've written her list of accounts and whether it was current or overdue, plus some other important pieces of information:

  • A mortgage (current)
  • A car loan (current)
  • A line of credit (current but maxed out)
  • A credit card (current but maxed out)
  • A credit card (overdue and almost maxed out)

Given her situation, what should she do to gain maximum benefit? We put her list in order of things she should pay down.

  1. A credit card (overdue and almost maxed out): Get this current as you do not want to have recent late payments reported to the credit bureaus and then try to pay it down to within 20 percent of the card's limit.
  2. A credit card (current but maxed out): Start by paying this down, ideally aiming to bring the balance to within 20 percent of the card's credit limit.
  3. A line of credit (current but maxed out): Pay this down to within 20 percent of the limit.
  4. A car loan (current): Keep this current. There is no need to pay this off faster than term of the loan.
  5. A mortgage (current): Keep this current. There is no need to pay this off faster than the term of the mortgage.

Here's why I am suggesting she pays them off in the above order:

First, she needs to get her overdue accounts current. Being maxed out isn't ideal but when it comes to your credit score, timeliness of your payments is more important to get current. That is, paying on time to not have a new late charge appear on your report is improvement! So getting current is a priority.

Second, she then needs to start "getting some room" in her credit availability and the best place to do this is by paying down revolving loans (i.e., credit cards and lines of credit). If possible, pay down the higher interest loans first.

Third, there is no need for her to pay off her installment loans faster than normal. As long as the payments are on-time and in full (and as long as the loan eventually gets paid off!) then these loans can be set on autopilot.

If you find yourself in a similar situation, order your accounts like I've done above and deal with them one at a time in that order.

Send me an email with our credit questionJeanneKelly@TheCreditOwl.com