Dear Creditnet: I was recently approved for a zero interest credit card with a $3,500 credit limit. The zero interest promotion lasts for the first 12 months. I’m looking to put the first $1,000 to great use by either paying off balances on 2 high-interest credit cards totaling $800 with monthly minimum payments of $20, or by paying off the balance on a $1,150 auto loan with monthly payments of $165. I'm not sure which will boost my credit score the most. Can you answer this?
Answer: My recommendation is to always pay off the highest-interest credit card debt first. Not only is it the financially smart move because it will save you the most money in interest, but your credit scores will also benefit the most as you pay down your credit card debt and improve your overall credit utilization ratio.
Auto loans aren't considered revolving credit, which means they're not included in your credit utilization. Credit cards, on the the other hand, are the key component of your credit utilization ratio, which accounts for about 30% of your FICO credit score. So while it's a great idea to pay off your auto loan early if you can, paying down its balance won't have as much of an immediate impact on your credit scores.
In fact, as strange as it may sound, paying off your auto loan and closing the account could even have a negative effect on your FICO credit scores if you don't have other non-revolving credit as part of your credit profile. You see, your credit mix, which accounts for 10% of your FICO score, takes into account the number various types of credit accounts you have including credit cards, retail accounts, and installment loans. To maximize your credit scores, you want to show that you can responsibly handle a healthy mix of credit at the same time.
If you pay off an auto loan and then the only open accounts you have left are credit cards, your credit scores could be negatively affected. Once you initiate the balance transfers to your new 0% interest credit card, make sure you have a solid payment strategy in place and then stick to it! Don't wait until month twelve to pay off the balance before the 0% interest promotional period ends. Ideally, you should have the entire balance paid off at least a month before your twelve months is up.