Paying off credit card balances is one of the primary goals we at credit.org help people achieve. It’s on practically everyone’s roadmap to financial freedom.
The process of paying down a credit card balance may seem obvious, but there are some things anyone who pays off a credit card balance should know.
1. You should be doing this every month.
For most people, making that final payment to wipe out a credit card balance is a special event. Many clients we work with spend years grinding toward that final goal.
But that isn’t the way it’s supposed to be. If you’re using credit cards wisely, you’re paying off your balances in full every single month.
If you keep your credit card use under control and pay off the entire balance each month, you are operating under the best-case scenario; you get the positive impact to your credit score that comes from healthy credit card activity, and you pay little to nothing in the way of fees and interest for using the credit card.
Getting into this healthy routine of using your credit cards sparingly and paying off the balances in full every month isn’t easy; the credit card companies make more money if you carry big balances from month to month, so that’s what they encourage. It’s up to each of us to resist the temptation to charge more than we can afford to repay at the end of the month.
2. Credit counseling can help for as long as you need it.
With credit counseling, you get personalized coaching and assistance to help you create a budget and a plan to become debt free over a set period of time.
You can even sign up for a Debt Management Plan (DMP) to really increase your chances of success.
DMPs are optional, and they aren’t for everyone, but if you’re a good candidate, a DMP lets you consolidate all of your monthly credit card payments into one payment that you send to a credit counseling agency. Then the credit counseling organization distributes your payments to your creditors, ensuring everyone is paid on time.
A major benefit of the DMP is many creditors will reduce the required monthly payment amount, lower or suppress interest, waive fees, and re-age or bring the account current, and other concessions to make it easier for you to pay off that credit card balance in full.
There are sacrifices to be made in exchange for these concessions, though. You may not open any new credit or use credit cards at all while on a DMP. Your cards will be cut up and accounts closed when you begin the repayment plan.
But one thing that is crucial to bear in mind is that a DMP is here as long as you need it. If your financial circumstances change and you’re able to manage your finances on your own, you’re always free to leave the DMP, reapply for credit card accounts, and resume your normal payments.
3. You shouldn’t close an account after you pay it off.
Paying off a credit card balance will feel like a liberating moment. You’ll probably be tempted to close the account and never look back.
Believe it or not, that’s not usually the best idea.
Paying off a balance helps your credit score in several ways. The good payment habits you’ve shown in the process of paying off the debt will certainly help your credit history and keep your score healthy. In addition to that, there are benefits from having an open account with an available balance on it. As long as you don’t go out and max out the card again, that available balance will really help your credit score.
Credit scores also reward you for having a good credit mix. So it’s better if you have different kinds of loans, like auto, home, and revolving debts like credit cards. Closing your credit card account may hurt your mix and lower your score.
By all means, feel free to celebrate when you pay off that big credit card balance; cut up the credit card into confetti. But don’t close the open account, and your credit score will thank you.
4. Paying off may not boost your score as much as you expect.
We talked about how having an available balance helps your score, and how a good credit mix is important, but the truth is, your score might not go up that much when you pay off the balance.
The biggest factor in your Fair Isaac Corporation (FICO®) score is payment history at 35% (and it’s very important to your VantageScores as well). But if you were making timely payments before you paid off the account, then you payment history already looks good as far as your credit score goes.
When we advise you to not close the account, that’s more about preventing your score from going down than ensuring it will go up. Your credit mix won’t change if you don’t close the account—which is a good thing, but doesn’t necessarily mean your score will go up.
The one factor where your score will probably improve is utilization. It’s 30% of your FICO and approximately 23%* of your VantageScore. And paying off a big balance will surely improve the overall utilization rate, so long as you keep the account open and don’t run up any more long-term debts on the account.
Once you’ve got the account paid off, the most important thing for your score is your payment history. Using credit wisely, paying off balances every month will be the most effective way to get your score up and keep it up in the long term.
5. The Crucial Next Step: Save.
Paying off your credit card balances in full is only one stop on the road to financial freedom. Your next steps after paying off your debts will have a big impact on our personal finances.
We’ve already talked about the importance of keeping the credit card account open and not running up any new debts with it. Once you’ve paid off that credit card balance, the next thing you should focus on is what you do with your regular credit card payment.
If you were paying $200 toward that credit card balance every month, you’ll be tempted to spend that extra $200 now that the balance is paid off. This is a critical moment for your financial health—you must use those funds you were sending toward credit card debt and put them into savings for your goals.
Your first goal should be to establish an emergency savings fund. Three months’ income is the minimum, and nine months’ worth would be better. Everyone needs to save for emergencies or job loss, but one thing to bear in mind is that your emergency fund should prevent the need to go deeply into credit card debt again in the future.
If you have an emergency home or auto repair, the best way to pay for it is out of your emergency fund, not by using a credit card. By using the money you were sending to credit cards, you’ll be able to painlessly establish this fund over time.
Once you’ve built up your emergency fund, you’ll be positioned to start saving for more fun goals, like vacations or a new car. Once you’re able to set aside extra money for the things you want, you’ll be well on the way to financial freedom.
Paying off credit card balances takes time and diligence, but if you do it and learn to handle your finances better in the process, you’ll be left in a much stronger financial position in the end.
And remember, help is available. Call us today for financial coaching that will help you create a budget, pay off your credit cards, and become more financially literate.