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-–that9rsquo;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.

Do this instead of getting a loan to pay off your credit card

Taking out a loan to pay off your credit card can be risky. There are other alternatives for paying off credit card debt.

By Naomi Mannino , February 29, 2016

  • Pay off credit cards with loan

Pay off credit cards with loan

Maybe you've heard that personal loans are easier to get at lower rates now, or that using a different type of credit can improve your credit score or help you pay off your credit card debt. But is it actually a good idea to take out a loan to pay down debt? Personal loans seem to be all the rage, so we reached out to two experts to find out what they tell their clients to do in various credit card debt situations.

"Since the recovery from the Great Recession, it's been easier to get lower rates on unsecured personal loans to pay off credit card debt," explains Thomas Nitzsche, spokesman for the nonprofit ClearPoint Credit Counseling Solutions. "But that doesn't mean it's a good idea for your situation. The trend points to the larger problem of people looking for a new, easy way out of debt."

Rather than using a loan to pay off credit card debt, these experts believe that direct, fast, and effective payment is the best way out. Here's what you should do to pay off credit card debt.

Call Your Creditors for Help Before Resorting to a Personal Loan

Did you know that if you're just a payment or two behind, and you know you're headed for trouble because of a job loss or medical problem, you can call your creditors for help?

"Many of the credit card companies and banks have financial hardship programs that reduce interest rates and fees considerably if you reach out to them early," says Nitzsche. He also adds that once you're three or more payments behind and are referred to a collections agency, you're no longer dealing with a creditor who can help you.

"Many of the credit card companies and banks have financial hardship programs that reduce interest rates and fees considerably if you reach out to them early."

"Your creditors can see your credit report, and they know if you could be approved for a balance transfer to another card or loan," he explains. "And if that's the case, they'd rather help you pay your debt to them." Nitzsche says it might take three or four phone calls, but it's worth it, especially if you have a financial hardship story to tell.

Let a Debt Management Program Consolidate Your Debt, Cut Interest Rates in Half

The reason a debt management program (DMP) is so effective at helping you pay down credit card debt quickly, Nitzsche says, is because the agency negotiates for drastically reduced interest rates and fees with all of your creditors and combines all your new payments into one payment made to the agency, which it disburses for you. It is not another loan.

Most of the largest banks and card issuers work with credit counseling agencies to keep you current on your payments through a DMP, explains Nitzsche, who advises searching for a nonprofit agency that's a member of the National Foundation for Credit Counseling.

According to Nitzsche, a DMP can lower the average interest rate by half, into the single digits — which may be lower than personal loan rates you might be approved for — and it can also lower the average monthly payment by 20%. The average ClearPoint client is on a DMP for fewer than four years (at an average debt of $25,000), which may be shorter than the term of a personal loan of that amount. The less time you're paying interest, the less you're paying overall.

As a condition of these lowered rates and fees in a DMP, the creditors close your accounts and you may not apply for new credit while in a DMP; however, Nitzsche says this forces you to learn to live within your means, and avoid charging more on credit or other bad financial habits.

Once you have completed the program, your credit will be restored, as creditors have been reporting your accounts "paid as agreed" during your payoff time. You will also be able to apply for a new credit card to use responsibly, an auto loan, or even a mortgage.

High Income? Try the Snowball Method

It's not uncommon for consumers to have high debt levels, even if they earn a lot, are otherwise good at saving, and have good credit, says Michael Garry, Certified Financial Planner and owner of Yardley Wealth Management. Despite that, he doesn't recommend that these people choose personal loans as a solution, "because their debt is usually at lower interest rates than what they would expect from a personal loan of that amount.

"Sometimes we find the debts could be managed through a low- or zero-interest rate complete balance transfer from a credit card company, with the expressed plan to pay off balances completely before that promotional rate expires," he adds.

Consider putting payments towards the smallest balances first, to get rid of debt accounts faster and free up money to go toward the larger accounts.

High earners may have more options for debt pay-down because they can liquidate assets or simply choose to spend less to make debt pay-down the priority. If that's the case, Garry considers using variations of the "snowball method" with his high-earning clients.

So what exactly is the snowball method? "Sometimes we put the larger payment toward the higher interest rates, but often we'll put it towards the smallest balances to get rid of more debt accounts faster and free up more money to go toward the higher interest accounts," Garry says.

Think credit counseling and a DMP can't help high-debt, high-income people? Nitzsche says the most-indebted ClearPoint client pay-offs range from $146,000 to $298,000.

The Upside to Using a Personal Loan to Pay Off Credit Card Debt

There's only one way that using a personal loan to pay off credit cards works out well.

In cases of good credit, Garry says, where a lower interest rate for an unsecured personal loan is approved for the entire debt balance, it can provide structure and payback terms at a length appropriate for your overall situation.

"Since it's not revolving credit, people make the payments and don't increase the balance like they could with a credit card," he notes. That's as long as they don't continue to charge on their credit card accounts, too, which only adds to their debt, Nitzsche warns.

"Often clients come in with both a large personal loan balance and several credit card balances, and explain they took out the loan to pay off their credit cards, but then continued to charge," Nitzsche says. That's when a personal loan will hurt, rather than help, your credit and overall financial situation.

In cases of good credit, an unsecured personal loan can provide structure and payback terms at a length appropriate for your overall situation.

The average debt balance was $20,698 spread across four credit cards in 2014, according to NFCC VP of Communications Bruce McClary and data from over 1 million counseled consumers.

So, if you have credit card debt with balances larger than $10,000, you may not be approved for an unsecured personal loan for the amount you need. "In that case you would still have the card balances and the loan balances, and it wouldn't solve your problem at all," Nitzsche says.

Explore All Your Options Before Turning to Personal Loans

High earner or not, both Garry and Nitzsche advise exploring all your personal options before taking out a personal loan to pay off your credit card debt, and never securing your cash, car, or home as collateral for a personal loan in case you get into payment trouble down the road.

Call all of your creditors several times to ask for help yourself, and take the time to speak with a debt counselor at an NFCC member credit counseling agency about how a DMP would work for you. Only then, without actually applying — because that will ding your credit — search and compare personal loan interest rates at your local credit union and online as well as collateral requirements, payment terms, and payment amounts to cover your credit card debt amount.

That way, you will clearly see which option will work best for you to finally get out of credit card debt, paying the least amount of interest for the shortest time. And if you need more information about paying down debt, consider reading the classic personal finance book by Dave Ramsey, The Total Money Makeover.

This article first appeared at DealNews.

The Christian Science Monitor has assembled a diverse group of the best personal finance bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link in the blog description box above.

Should I Pay Off One Credit Card or Reduce the Balances on All Debt?

You’re ready to pay down your credit card debt, but you carry a balance on multiple cards. Use this background on credit card debt and interest payments to help you decide whether it’s best to pay off one credit card, or work towards paying down multiple cards at the same time.

Pay off debt faster with a balance transfer.

Pay off credit cards with loan

Understanding Your Debt-to-Credit Ratio

Your debt-to-credit ratio (also known as a debt utilization ratio) equals your debt divided by your total credit, which might be the sum of several lines of credit.

Your debt-to-credit ratio is an important factor in determining your credit score. 1 It’s best to keep your debt-to-credit ratio low; you should aim to have the sum of your balances equal 30% or less of available credit.

Pay Off High-Interest Credit Cards First

Pay the minimum payment on all credit cards each month to avoid penalties. After that, work toward paying off the debt on the card with the highest interest rate. While some advocate for paying off your smallest debt first because it seems easier, you’ll save more on interest over time by chipping away at high-interest debt. 2

One caveat: If you are close to the maximum credit limit on one card, start by paying down that card so that the interest charges don’t send you over your credit limit, resulting in fees.

What About 0% Interest Credit Card Offers?

Many credit cards have 0% interest introductory offers. Transferring your balances to cards with a zero percent intro APR can give you the chance to save on interest while paying off your debt. But read the fine print. Some credit cards charge a “balance transfer fee” of 3%. Also, learn how long the offer is good for—once it expires, your interest rate will increase and you could be charged accrued interest if the balance hasn’t been paid in full before the introductory rate expires.

Pay Off Debt Faster with a Balance Transfer.

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Is a home equity loan a good way to pay off my credit card debt?

Pay off credit cards with loan

Pay off credit cards with loan

If you have a large outstanding debt on one or more credit cards, you may be struggling to make any progress toward paying the debt down if you are only making minimum payments. It can take years of making the minimum payment to actually pay off the balance, because interest rates make up a large portion of each payment. Also, since most credit cards have variable interest rates, your minimum payment amount increases as rates climb higher. Add in multiple credit cards in this situation with different due dates and minimum payment amounts and you can quickly find yourself in a credit mess. Thankfully, if you own your home and have some equity built up, you can apply for a home equity loan, which you can then use to pay off credit card debts.

There are a few important characteristics of a home equity loan to consider when trying to decide if this strategy makes sense to pay off your credit card debt. The most important aspect of a home equity loan is the risk you take by securing the loan with your home as collateral. In the event you are unable to repay the loan, your house can be seized and sold by the lender to collect on funds owed. For many families, this risk may be too great. Credit scores are repairable, but uprooting your family due to foreclosure is not as easy to fix. Moreover, a home equity loan can also be more expensive than a similar debt consolidation loan, as it requires an appraisal of the home, along with other fees that are typically seen in a primary mortgage transaction

One of the great advantages to using a home equity loan to pay off your credit card debt is the low interest rate afforded to these secured loans. Most home equity loan rates are just a step higher than primary mortgage rates, and they are usually much lower than any of the high rates on your credit cards. Therefore, using a home equity loan can help you pay off your credit card debt much sooner, since less money goes toward interest payments. The interest charged on a home equity loan is also tax deductible for those who itemize deductions on their tax return. You are, therefore, likely to find the combination of interest and tax savings of this option advantageous over other debt management strategies.

Using a home equity loan to satisfy credit card debt can be seen as essentially refinancing the debt. Doing so leaves the previously outstanding credit cards with full available credit limits. This increases your credit score quite a bit, as your credit utilization rate makes up nearly one-third of your total credit score.