Should You Pay Off Credit Cards with Low Balances or with High Interest Rates?
If you’re paying off credit cards, sometimes it’s easy to decide which cards to pay off first–-one may have a low enough balance to pay off in only two or three payments; or one card may have a much higher interest rate than the others. If you want to improve your credit score, though, it's the credit limit for each card that matters most.
How Your Credit Limit Affects Your Credit Score
For each card you own, you have a credit limit-–this is the maximum balance you can have on your card. Part of your credit score records how well you mange the credit you have. So if you have a card with a high credit limit but only have a small balance on that card, this is a good sign that you are careful with your spending, which increases your credit score. Yet if your credit card balances are very near your credit limit or if you are “maxed out,” it looks as though you can’t handle the credit you have--and that lowers your credit score.
What About the Interest Rate?
Many advisors suggest paying off the higher-interest cards faster because you will spend less money in interest payments. They’re right, but this only affects how much money you will spend in paying down your cards--not your credit score. Lenders look only at how much credit you’re using and how quickly you’re able to pay it back. So if you put off paying down a card that's close to its credit limit just because it has a low interest rate, your credit score could suffer. It’s better to bring down the balance a bit first on a card that’s near its limit. Then, after you’ve brought that balance down, you can start paying off your higher-interest rate card faster.
What about Cards with Low Balances?
If you have a card with a low enough balance that you can completely pay it off in only one or two payments, go ahead-–that’s one less card to worry about, and only one or two months of lower payments to your other cards won’t hurt your score. But if it would take longer, focus on bringing down your other balances first.
Using Your Credit Limits to Decide on a Payment Plan
Check the credit limits for all of your credit cards. Then, check each card’s balance and compare it to the credit limit. The card with the balance closest to the credit limit should be paid off fastest. This may not be the card with the highest balance, however. If you have two cards with a $2,000 balance each, but one has a credit limit of $2500 and the other has a credit limit of $4000, the one with the $2500 credit limit should be paid down fastest because you have the least available credit on it. The more available credit you get as you’re paying down your cards, the better your credit score.