Posted by Kromey at 5:54pm Sep 13 '10First and foremost, pay off the credit cards. These are debts not backed by equity, such as a car or a house, and as such they weigh much heavier against you if you have a high debt-to-credit ratio. The ideal for this ratio is around 30% or less.
Secondly, and almost as important, be sure that your expenses-to-income ratio is low. Basically this just means living within your means, i.e. spend less than what you earn. This does not mean that you cannot occasionally make big purchases (e.g. car, house, hell even a big-screen TV can be okay), even on credit, but rather that your usual spending habits should not exceed your income. (However, do keep your debt-to-credit ratio in mind if making a big purchase on credit.)
Second-point-fively, build up savings. It won't help your credit score, at least not directly, but having something other than more debt to rely upon for those unexpected expenses will save your ass.
Now, I'm going to disagree with Essie on one thing that I consider a key point: Do use your credit card(s). Use them for your day-to-day expenses. Do not run up your balance, and do pay it off in full each month (obviously this bit applies after you've paid off your credit debts). If you have multiple cards, make sure you're using each of them; if you have 6 or fewer and tracking multiple cards is difficult, then cycle them, using one one month, another the next, etc. The key point here is that if you don't use a credit card for long enough, it will effectively be ignored when calculating your credit score. This means a drop in your total available credit, and if you have any kind of debt (e.g. a car or student loan), then suddenly your debt-to-credit ratio jumps up significantly, which can have a huge negative impact on your credit score.
Now, if discipline with the use of those cards is too hard, if you're the type of person who too easily spends too much just cuz you're using plastic, then instead take Essie's advice and use cash. Just be sure, however, that you do put one charge on each every 6 months at least, otherwise you risk that credit being discounted and your score dropping significantly.
One thing to watch out for here is the grace period on your cards. Most offer 25-30 days of no-interest on new transactions if you pay off your statement balance in full each month. That means that, if you pay in full each month, you can usually avoid paying interest at all on new charges if you continue to pay in full each month.
As for how to pay off the credit cards, there's two schools of thought on this one, one being the cheaper in the long run, the other having less tangible but nonetheless significant psychological benefits.
Both methods start with the same step:
0) Figure out how much you can afford to pay to your credit cards this month.
The cheaper way:
1) Lay out each of your credit card debts, along with your APR on each.
2) Identify the one that will result in the highest interest charge this month.
3) Pay minimum (or just above minimum) on your other cards, and pay as much as you can afford into the high-interest charge card. This will reduce that debt as much as possible, which will naturally reduce how much interest you get charged.
4) Repeat this process each month, as the card with the highest interest charge may change (e.g. a high-balance, medium-interest card might be the highest interest charge, but as that balance gets paid down, a lower-balance, high-interest card might usurp it as the highest interest charge).
This method results in paying the least amount possible overall to pay off your credit cards. This can be further reduced if you keep your eyes open for credit consolidation opportunities, such as zero- or low-fee balance transfer offers from your credit cards that could allow you to transfer a high-interest balance to a lower-interest card without paying too much in transfer fees. A loan from you bank may allow you to pay off your credit cards, and then you make monthly payments to repay the loan, but be careful -- unsecured loans often have much higher interest rates than credit cards.
The psychologically-beneficial way:
1) Identify the smallest debt.
2) Make minimum (or slightly above minimum) payments to all the others, and as much as you can afford toward the smallest debt.
This simple process usually results in paying more money in the long run, however it has a psychological bonus of showing you clear milestones marking your progress: That magical date when you get a credit card statement announcing a $0 balance! Additionally, you'll find that the money you can afford to pay towards your credit cards feels bigger as you pay off those smaller debts, because you'll be stretching it between fewer and fewer debts.
I used this method to crawl out from under 11k of credit card debt. Yes, I could have paid less overall and been done faster with the first method, however the psychological benefit of being able to say "Yes! That's another card fully paid off that I don't have to worry about anymore!", as well as that feeling that I had more money with each card that was paid off, was priceless for me and for my particular brand of fiscal discipline.
A hybrid approach where you pay off the more expensive (i.e. higher interest charge) debts first and then, once a debt is low enough, focus on paying that off entirely regardless of whether another is more expensive might also work for you.
Really, it boils down to finding a way that works for you, and then sticking to it. It'll take time, and at times it will be immensely frustrating, but you can do it, you can pay off that debt.
One last thing I want to mention: If you'll notice, virtually everything above applies specifically to credit card debt. This is because these debts are the most toxic to a credit score, and in fact other common types of debt -- car loans, mortgage, and sometimes even student loans -- can actually be beneficial to a credit score (provided you are making all of your payments on time). Why? Because they show that you are capable of paying your bills on time, that you are responsible enough to manage big debts like those, and thus you are worthy of being lent money. Also, perhaps counter-intuitively, someone with no debt at all will actually find themselves with a lower credit score than someone with debt and a good debt-to-credit ratio (all other things being equal) -- someone with debt already is considered more lend-worthy because they already have debt. (No, I don't really understand the logic here either, but just play their game and keep a small amount of debt on your report.)
That said, even for these types of debts, if you can afford to do make payments above the minimum payment amount, as that will pay off your debt faster and usually save you interest in the long run. Additionally, most lenders will credit future payments with anything you pay above the minimum, which makes future minimum payments smaller; this means that if something unexpected happens and you suddenly find yourself tight on money, you can pay a lot less than you normally would have had to without penalty.
By way of example, my usual minimum payment on my car loan is $329.39. Each month, I pay $350. The minimum payment amount for my next payment? $90.85. That's nearly an extra $250 to get me through a hard time if I need it, and if I don't (as I hope) I will pay off my car loan before the 5-year maturity date and will have paid less overall. (I plan on bumping my monthly payment up to $400 once I get my credit cards paid off again (had a sudden slew of medical bills stack up, plus sending [private] back to college).)
Secondly, and almost as important, be sure that your expenses-to-income ratio is low. Basically this just means living within your means, i.e. spend less than what you earn. This does not mean that you cannot occasionally make big purchases (e.g. car, house, hell even a big-screen TV can be okay), even on credit, but rather that your usual spending habits should not exceed your income. (However, do keep your debt-to-credit ratio in mind if making a big purchase on credit.)
Second-point-fively, build up savings. It won't help your credit score, at least not directly, but having something other than more debt to rely upon for those unexpected expenses will save your ass.
Now, I'm going to disagree with Essie on one thing that I consider a key point: Do use your credit card(s). Use them for your day-to-day expenses. Do not run up your balance, and do pay it off in full each month (obviously this bit applies after you've paid off your credit debts). If you have multiple cards, make sure you're using each of them; if you have 6 or fewer and tracking multiple cards is difficult, then cycle them, using one one month, another the next, etc. The key point here is that if you don't use a credit card for long enough, it will effectively be ignored when calculating your credit score. This means a drop in your total available credit, and if you have any kind of debt (e.g. a car or student loan), then suddenly your debt-to-credit ratio jumps up significantly, which can have a huge negative impact on your credit score.
Now, if discipline with the use of those cards is too hard, if you're the type of person who too easily spends too much just cuz you're using plastic, then instead take Essie's advice and use cash. Just be sure, however, that you do put one charge on each every 6 months at least, otherwise you risk that credit being discounted and your score dropping significantly.
One thing to watch out for here is the grace period on your cards. Most offer 25-30 days of no-interest on new transactions if you pay off your statement balance in full each month. That means that, if you pay in full each month, you can usually avoid paying interest at all on new charges if you continue to pay in full each month.
As for how to pay off the credit cards, there's two schools of thought on this one, one being the cheaper in the long run, the other having less tangible but nonetheless significant psychological benefits.
Both methods start with the same step:
0) Figure out how much you can afford to pay to your credit cards this month.
The cheaper way:
1) Lay out each of your credit card debts, along with your APR on each.
2) Identify the one that will result in the highest interest charge this month.
3) Pay minimum (or just above minimum) on your other cards, and pay as much as you can afford into the high-interest charge card. This will reduce that debt as much as possible, which will naturally reduce how much interest you get charged.
4) Repeat this process each month, as the card with the highest interest charge may change (e.g. a high-balance, medium-interest card might be the highest interest charge, but as that balance gets paid down, a lower-balance, high-interest card might usurp it as the highest interest charge).
This method results in paying the least amount possible overall to pay off your credit cards. This can be further reduced if you keep your eyes open for credit consolidation opportunities, such as zero- or low-fee balance transfer offers from your credit cards that could allow you to transfer a high-interest balance to a lower-interest card without paying too much in transfer fees. A loan from you bank may allow you to pay off your credit cards, and then you make monthly payments to repay the loan, but be careful -- unsecured loans often have much higher interest rates than credit cards.
The psychologically-beneficial way:
1) Identify the smallest debt.
2) Make minimum (or slightly above minimum) payments to all the others, and as much as you can afford toward the smallest debt.
This simple process usually results in paying more money in the long run, however it has a psychological bonus of showing you clear milestones marking your progress: That magical date when you get a credit card statement announcing a $0 balance! Additionally, you'll find that the money you can afford to pay towards your credit cards feels bigger as you pay off those smaller debts, because you'll be stretching it between fewer and fewer debts.
I used this method to crawl out from under 11k of credit card debt. Yes, I could have paid less overall and been done faster with the first method, however the psychological benefit of being able to say "Yes! That's another card fully paid off that I don't have to worry about anymore!", as well as that feeling that I had more money with each card that was paid off, was priceless for me and for my particular brand of fiscal discipline.
A hybrid approach where you pay off the more expensive (i.e. higher interest charge) debts first and then, once a debt is low enough, focus on paying that off entirely regardless of whether another is more expensive might also work for you.
Really, it boils down to finding a way that works for you, and then sticking to it. It'll take time, and at times it will be immensely frustrating, but you can do it, you can pay off that debt.
One last thing I want to mention: If you'll notice, virtually everything above applies specifically to credit card debt. This is because these debts are the most toxic to a credit score, and in fact other common types of debt -- car loans, mortgage, and sometimes even student loans -- can actually be beneficial to a credit score (provided you are making all of your payments on time). Why? Because they show that you are capable of paying your bills on time, that you are responsible enough to manage big debts like those, and thus you are worthy of being lent money. Also, perhaps counter-intuitively, someone with no debt at all will actually find themselves with a lower credit score than someone with debt and a good debt-to-credit ratio (all other things being equal) -- someone with debt already is considered more lend-worthy because they already have debt. (No, I don't really understand the logic here either, but just play their game and keep a small amount of debt on your report.)
That said, even for these types of debts, if you can afford to do make payments above the minimum payment amount, as that will pay off your debt faster and usually save you interest in the long run. Additionally, most lenders will credit future payments with anything you pay above the minimum, which makes future minimum payments smaller; this means that if something unexpected happens and you suddenly find yourself tight on money, you can pay a lot less than you normally would have had to without penalty.
By way of example, my usual minimum payment on my car loan is $329.39. Each month, I pay $350. The minimum payment amount for my next payment? $90.85. That's nearly an extra $250 to get me through a hard time if I need it, and if I don't (as I hope) I will pay off my car loan before the 5-year maturity date and will have paid less overall. (I plan on bumping my monthly payment up to $400 once I get my credit cards paid off again (had a sudden slew of medical bills stack up, plus sending [private] back to college).)
My advice: - Kromey