Credit health is a delicate balance of liquidity and debt. Although borrowed money can facilitate and even boost your credit score, the benefits of debt reduction are obvious. The problem is, which debt should be paid first?
When credit repair and financial stability are the goals, there are several factors to consider, including:
- Money saved. Accruing interest and monthly payments are at the forefront of debt concerns. Make a list of your current responsibilities in order of monthly payment and interest. Which debt costs you the most in interest and monthly expenses? If these debts are not one in the same, which repayment would improve your savings the most?
- Credit utilization. The elite maintain a credit utilization ratio of 25 percent or less. The amount you owe vs. your total credit limit accounts for 30 percent of your credit score, a factor you cannot afford to ignore. A low ratio equals lower risk and better credit health. Consider how each debt affects your credit utilization ratio. Paying off a larger debt could result in greater improvements.
- Debt-to-Income (DTI) ratio. Like credit utilization, DTI ratio is used to measure financial risk, a factor that can open or close several doors. For example, while mortgage brokers are prohibited from lending more than 43 percent of an applicant’s gross income, they are unlikely to work with you if your current DTI ratio is too high. Consider your goals and needs when deciding which debt to focus on first.
- Liquid savings. While it’s important to pay off debt, you shouldn’t sacrifice your emergency fund to do it. Aim for three months of liquid savings in the bank and then tackle your debt. Consult your budget to determine how to use your savings for debt reduction without compromising your financial safety.
- Ability. Based on your calculations, which debt can you afford to repay? There are several schools of thought that suggest how to pay off debt, but ability is perhaps the most important consideration. For example, do you have the ability to repay a single debt within one year? Six months? Removing a burden quickly is sometimes the best path. Calculate payoff dates for each debt to determine your options.
- Emotional well-being. We all have our emotional leanings. Which debt bothers you the most? Why? Whether it’s a student loan or a long-term credit card balance, stress plays an important role in the credit repair process. Talk to our legal team about your feelings and whether your inclinations represent the correct choice. It’s never too late to make a change.