Which Debt Repayment Strategy Does the Most for Your Credit Score?

The following is presented for informational purposes only and is not intended as legal advice or credit repair.

It's a question we hear a lot: "I want to build my credit score - which debt should I pay off first: a credit card or a line of credit?"

Debt repayment is a marathon, after all. Most of us are always working on at least one debt, and when you're juggling multiple debts, it's smart to wonder which debt to target first. If building your credit score is your top money goal, it's helpful to understand how debt impacts your score, so you can make an informed decision on how to tackle that debt.  

Standard disclaimer to start: there’s never any guarantee that any credit-related action you take will improve your credit score by any amount. We know in a very general sense what most major credit scoring models use as a basis of their calculation, but the actual formulas used are complex and proprietary. It takes a long time and a lot of hard work to build a great credit score. 

Understanding how debt impacts your credit

To begin, here’s a quick reminder of the major factors examined in the FICO scoring model, which is one of the more popular, widely-used models:

• Payment history (35 percent)
• Amount owed to all creditors (30 percent)
• Length of credit history (15 percent)
• Amount of new credit (10 percent)
• Types of credit in use (10 percent)

As you can see, how much you owe is the second most important factor in your score. Assuming that you've been able to make your monthly payments consistently and haven't opened a ton of new accounts recently, simply paying down your debts is the likely the most impactful thing you can do for your credit score.

Reduce your credit utilization ratio

Your credit score judges your “amount owed to creditors” level not as a measure of your overall debt, but as ratio of debt to available credit. If you used $5,000 of a $10,000 credit limit you would have the same credit utilization ratio (50 percent) as someone who used $500 of a $1,000 credit limit.

Generally speaking, the lower your credit utilization ratio is the better it is for your score. Most experts suggest trying to stay below 30 percent utilization, with your score likely to suffer once you go over 50 percent.

It’s important to note, however, that FICO factors credit utilization in two ways – on an account-by-account basis and as an overall reflection of your debts and limits. This means that if the utilization ratio is low on most of your cards, but one of your accounts is close to maxed out, that will likely have a negative impact on your score.

So, if you have multiple credit cards and you're trying to decide where to concentrate your repayment efforts, check the limits on each card. If you’ve got any accounts where you’re using more than 50 percent of the available limit, that may be where you want to start. If the utilization ratio is below 30 percent for all of your cards, then you may want to focus on whichever account has the highest interest rate.

Lines of credit vs. credit cards

When it comes to lines of credit, it can be tricky to pin down their impact on your score. Different scoring models use different rules and they can vary pretty wildly.

The confusion is in how you classify the line of credit – as revolving credit or as an installment loan. Only revolving credit accounts are factored into your credit utilization ratio. Installment loans are considered differently.

A regular line of credit, like a business line of credit, is usually considered to be revolving credit and would be treated exactly the same as a credit card.

A home equity line of credit (HELOC), however, may be considered revolving credit or an installment loan. In many cases it depends on the size of the available credit. A general rule of thumb is that a HELOC over $50,000 is usually factored as an installment loan, while anything below that is considered a revolving line of credit.

So which should you pay off first? Again, it’s difficult to know for sure. I would suggest that if your line of credit is on the smaller side, treat it the same as a credit card and use the rules listed above. If it’s a relatively large HELOC, it’s probably in your best interests to pay the credit card debt first.

And while we didn't address it here, the same goes for mortgages, car loans, and student loans - if credit building is your focus, work on reducing your credit card debt, while keeping your loans current.

If you're currently struggling with an overwhelming amount of credit card debt, a debt management plan can help. See how this nonprofit option can accelerate your debt repayment.