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Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions.
This week’s episode starts with a discussion of impulse shopping, and how pandemic-related anxiety can cause us to overspend as we try to comfort ourselves and assert control.
Then we pivot to this week’s question from Corey, who asks, "What is a better method of paying off credit card debt and raising your credit scores? Should I reduce my credit utilization on all my cards or pay off one card with the highest rate?"
Check out this episode on any of these platforms:
People love to argue about the “best” approach to paying off credit card debt. Is it the debt snowball (paying off debts by size, from the smallest to the largest)? The debt avalanche (paying the highest rate debt first)? The debt tornado (paying off the debt that enrages you the most)?
Each method has its pros and cons. What matters most, though, is picking an approach that will motivate you to continue paying down the debt. Paying your highest balance first may save you a bit more in interest, but many people find that targeting their smallest or most hated debt gives them the psychological victory they need to keep going.
If your primary goal in paying down debt is to build or rebuild your credit scores, it can help to understand how credit scoring formulas view your debt. The formulas look at how much you owe relative to your credit limits on individual accounts as well as across the board. Ideally you would have large gaps between those balances and your limits. The scores also take into account how many accounts have balances. You can pay down your accounts simultaneously or target the account closest to its limit, but you’ll likely get a bigger change faster by eliminating smaller balances first.
It’s also important not to close credit cards if your goal is to improve your credit. Shuttering accounts typically won’t help your scores and likely will hurt them.
If you don’t have many accounts or you’re trying to rebuild damaged credit, you also could consider asking someone who’s responsible with credit to add you as an authorized user to a credit card.
Don’t obsess. There are many ways to pay down debt. What matters is that you’re paying it down.
Keep credit cards open. It can be tempting to close one once you finally pay it off, but that can actually damage your credit.
Consider borrowing credit mojo. Becoming an authorized user on someone else's card can help increase your credit age and reduce overall credit utilization.
More about paying down debt and improving credit on NerdWallet:
Sean Pyles: Welcome to the NerdWallet Smart Money podcast, where we answer your personal finance questions and help you feel a little smarter about what you do with your money. I'm Sean Pyles.
Liz Weston: And I'm Liz Weston. As always, be sure to send us your money questions. Call or text us on the Nerd hotline at 901-730-6373. That's 901-730-NERD, or email us at [email protected].
Sean: And while you're at it, please rate, review and subscribe wherever you're getting this podcast. Also, I just wanted to thank all of the listeners who've sent us their money questions recently. We've had such interesting and insightful questions, and we can't wait to answer them. So please, please keep them coming.
Liz: Absolutely. In this episode, we're going to talk to credit pro Bev O'Shea, about how to improve your credit while paying off debt. But first, in our This Week in Your Money segment, Sean and I are going to talk about COVID impulse shopping, how to spot it, what it means [and] how to curb it.
Sean: Right. This is something that I have definitely been guilty of, especially in the first few weeks of the pandemic. And this discussion is partially inspired by this article I read recently in The New York Times titled "When Impulse Buys Make You Feel Safe." The piece by Kaitlyn Greenidge was about how she impulse purchased a toy vacuum for her kid after scrolling through the horrors of her social media feed for like several hours.
Sean: And that so struck home with me because I've done the same thing. It's like you want it to be up to date on what's happening, but then you feel so scared that you need to do something to make you feel safe and in control. And it's just this dangerous cycle and you end up with all of this junk that you don't need. Like in the beginning of the pandemic, I purchased new cooling sheets for my bed. I purchased a fancy vacuum. I bought a velvet tracksuit. So basically, I was like ...
Liz: Velvet tracksuit?
Sean: Yeah. I still wear it a lot. Basically, I was nesting. I was buying things to make me feel secure and comfortable in my own home.
Sean: Did you do any of that when COVID first hit?
Liz: I'd love to say no, but I am so embarrassed at how much money I spent in the first couple months. I was doing the same thing you were doing, nesting, and I was ordering food like it was going out of style. And I think, if you remember those first few weeks, in the cities, it was really tough to get anything.
Liz: So I would order from Amazon. I would order from Costco. I would order from the local grocery store. And one day, three orders came at once. I had so much bread and milk that I was giving it away to neighbors. It was just like, "Please come take this."
Sean: We all had such a scarcity mindset. It seemed like we weren't going to be able to get anything and we didn't know if we were going to be able to leave our houses. I mean, I expected to come down with COVID any day. I mean, right when COVID stay-at-home orders came down, I had just gotten back from a trip to New Orleans, and so I figured that I was going to get sick immediately.
Sean: So I had to stock up and just buy stuff so I could live off of soup indefinitely.
Liz: Well, I recently interviewed Dan Ariely. He is a behavioral economist. He wrote a wonderful book called Predictably Irrational. And this topic came up, the topic of impulse shopping. And his take on it is, when you buy something, there's that you see something, you acquire it, and that little rush of endorphins, that little rush of success, "I win," was something that was countering all the fear and all the uncertainty we had.
Liz: So there's actually brain chemicals going on that explain why we do this, but there's the other side to it, which is the credit card debt.
Sean: Yeah. Yeah, you have to pay for it eventually. And another thing I think that's related to this and the COVID fear that Greenidge discusses in her column is that part of it is about control. Being able to purchase something from your home, especially something that can bring you joy and make your home more homey, made me feel like I could still better my life and interact with things, even if it's just with material possessions.
Liz: Yeah. And his point was that we can take that and we can funnel it somewhere else. We can take that need for control and do other things. One of the things he suggested, interestingly enough, was exercise, and not exercise that's sort of indefinite. Like going for a walk, OK, that's great, but you can't improve. Whereas if you task yourself with trying to do more pushups or more situps, every time you do it, you can track the progress. And it was like a light bulb went off in my head. I love walks, I love hikes, but that feeling of success, control and achievement when you're actually pushing yourself physically ... My husband's a big chin-up person, and being able to rack out 25 chin-ups, three sets of 25, whatever the heck he does, it's something he's really proud of, and I think it gives you that same sort of rush without the potential downside of having to deal with the bill.
Sean: Yeah. I've been trying different tactics as well to curb my impulse shopping, and one has been working out. I figured, since I'm in my home all the time, I might as well try to be active in one way or another, but I've also been doing more virtual window shopping, like putting stuff in carts and just like leaving it there, honestly, kind of hoping that they mail me a coupon later on.
Liz: That could work.
Sean: Maybe end up buying it.
Sean: But then, at the end of the week after I don't buy stuff, I'm putting the money that I didn't spend into my savings to shore up what I have in there. And I'm also doing that. I'm kind of alternating putting the money I don't spend into my savings, and also putting the money that I didn't spend toward causes that still need help, because while the news about the Black Lives Matter protests may have faded from our social media feeds, they are still very much going on and organizations and individuals need our support, too. So that helps me feel like I have some sense of control, however marginally and remotely, to help effect change.
Liz: Yeah. And we're being kind of light about this, but obviously there are a lot of people that are out of work. They're really scared. They're trying to cut back on their spending . . .
Liz: And maybe they're looking back and going, "Oh, I shouldn't have bought this. I shouldn't have bought that." Everybody makes mistakes with money. Leave it in the past; we've got to move forward. And one of the things that I always do at the first of the year after the holidays is I unsubscribed from everything. I unsubscribed from all these newsletters. I don't go to the sites. And we've talked about this before: I don't go to the sites that are clearly just pushing people to buy, buy, buy.
Liz: There's sites like the Non-Consumer Advocate. I love that. I love sites about minimalism.
Sean: Oh. Interesting.
Liz: I love sites about frugality. All this stuff is sort of countering this push to be a consumer to buy and it can really help you step back from that and not get sucked into this, "I need this shiny thing right now."
Sean: Yeah, it's hard to break that habit because it becomes almost compulsive, this urge to purchase things. And there are so many roundups of the daily deals and this and that. It's like, OK, now isn't the time for that, now's the time to focus on more important things like your savings, like the costs that are important to you. And also, if you have taken a hit to your income, making sure that you can ride out whatever rough patch you're in right now for the foreseeable future.
Liz: Yeah, absolutely.
Sean: All right. Well, with that, I think that we can move on to this week's money question and our conversation with Bev.
Liz: All right. This episode's money question comes from Corey. They ask, "What is a better method of paying off credit card debt and raising your credit scores? Should I reduce my credit utilization on all my cards or pay off one card with the highest rate?"
Sean: I really like questions like this because they kind of get to the choose-your-own-adventure aspect of personal finance and paying off debt. Yeah, everyone wants to raise their credit and pay off their debt, but what's the best way to do it? It's kind of up to you. But fortunately, there are some easy go-to strategies that Corey can tap to meet their goal.
Liz: Exactly. OK, so the help with this question, on this episode of the podcast, we're talking with one of our favorite credit pros, a Nerd who knows this stuff through and through, Bev O'Shea.
Sean: All right. Let's get to it. Hey, Bev. Welcome to the show.
Bev O'Shea: Thank you, Sean. I'm glad to be here.
Sean: I'm so happy to have you because we have been working together for like four years now and I've never had you on the podcast. So it's about time.
Liz: Long overdue.
Liz: So Bev, our listener, Corey, has a question that's right up your alley. They're wondering about the best way to raise their credit scores and pay off debt. Should they reduce the utilization on all their cards or pay off the card with the highest interest rate first?
Bev: Corey, you're asking about paying off the highest interest rate first versus pay off the smallest balance, it sounds like. Oftentimes, people get all worked up about which one to use when it really makes just a few dollars difference. You can use a calculator and figure it out. But for some people, paying off the smallest debts works better because they feel like they've won a psychological victory. It can also help your credit score just a little bit. If you have lots and lots of small balances, that can hurt your credit score.
Sean: So it seems like it's a matter of personal priorities here.
Bev: It can be. And usually, if you're managing your money well, and in my mind that would be [you are] able to pay off or almost pay off, at least make some progress on your debts, you are managing your money well. If you're making progress that way, your score is going to improve or it's going to stay good.
Liz: I actually read Corey's question a little bit differently. It seemed to me like they were saying, "Should I be reducing the balances on all my cards simultaneously?" In other words, sort of spread the payments around so the debt comes down at once. But it sounds like what you're saying is it might be better to pick one card and concentrate on that, and then go down the road of . . .
Bev: Yes, that's what I would do. There is some argument, but I think the best thing is to have a focus rather than to do it scattershot.
Liz: OK. That makes a lot of sense.
Sean: That's one thing that we come back to a lot when we talk about debt payoff. There's the debt snowball, there's the debt avalanche, there's the debt tornado. There are all of these different ways to pay off debt, but the most important path to pay off debt is the one that you're going to stick with. And that's a matter of knowing your own spending habits. If you really want to pay as little interest as possible, maybe the debt avalanche is the method for you. But if you want those little wins to keep you motivated, yeah, probably the debt snowball's going to be the way to go.
Bev: I think that's right. And oftentimes, people really do believe that the difference in actual money paid is a lot different than it is going to be. It's really worth doing the calculation.
Sean: Right. It's interesting because we have a calculator at nerdwallet.com, which we will link to in our show notes post, of course, and we put these numbers in. You can do a toggle between the debt avalanche and the debt snowball, and really, the difference is so small, it often isn't really worth it in my opinion. I'm someone who wants a lot of instant gratification, so that's why I like the debt snowball method personally. But yeah, you can play with it yourself and really figure it out. And, OK, do you want to save that money or do you want to pay off smaller debts as you go?
Liz: Well, paying off the smaller balances first is probably better if you’re focusing on improving credit. Your overall credit utilization will be the same regardless of which accounts you pay first, but the formulas also pay attention to how many of your accounts have balances, so eliminating some of those quickly can really help.
So Bev, what are some other ways that people can improve their credit?
Bev: One way that I have used with my adult children is I added them as authorized users to my credit cards. And what it did for them was lower their overall credit utilization rate, which is the percentage of your credit limits that you're actually using. And it also improved credit age. Credit age is kind of a minor factor, but it's hard for people who are young to have a very good credit age because they're young. But if someone who is older, like a parent or aunt or grandparent, adds them as an authorized user, they could get an older credit age. And the older person doesn't really have to take a risk if they don't want to. With my kids, I didn't give them cards.
Sean: I was just going to say, yeah, don't give them your cards and then there's pretty low risk.
Sean: But it's interesting that Corey's is focusing on utilization because it's something that can be a little hard to understand, but at the same time, it's one of the factors that will change your credit score the most week to week, depending on how much you're using. So basically, credit utilization, as you said, Bev, is how much of your available credit that you're using. So say one week you have way more purchases on your credit card than the week before, you'll see that in your weekly update on your credit score. But then when you pay that off, it'll go right back up. So it can really lead to some dramatic fluctuations. I've had my score drop or go up by 10 points in a given week, depending on how much I'm spending. So I think it's smart to focus on that for improving your credit, but you also want to make sure that you're still steadily paying down whatever debt you may have.
Bev: Agreed. You can also make payments mid-cycle.
Sean: Yeah. Because I'm a big nerd, I pay my credit card almost every single day just to keep that utilization at zero. Really, I do.
Liz: OK. Well, I think we should drill down a little bit on this because there's a lot of misunderstandings about what kind of balances count toward your credit utilization. And people who pay off their cards every month think, "Oh, I don't have to worry about it because I pay off my cards." It doesn't actually matter if you pay your card in full every month, as you should, by the way, because the balance that matters is the balance on the day that the credit card issuer decides to report it to the credit bureaus. So you could pay that balance off in full the next day and the credit bureaus wouldn't know. So that's why it's so important to keep your credit utilization low throughout the month, and also to pay attention to the credit utilization or the balances on each card, as well as your credit utilization overall.
That's another nuance that people sometimes miss. They think that if their overall credit utilization is low, they're fine, but if they have one card that's maxed out or anywhere close to it, that can be affecting their score.
Bev: Yes. And another mistake that people make is they're so happy when they finally pay an old balance off that they celebrate by closing the card.
Sean: Ah. Yes.
Liz: Not a good idea. Tell us why, Bev.
Bev: Well, it's because your credit utilization is figured both per card and overall, but that can drop your overall credit utilization significantly and hurt your credit. And people are really disappointed because they feel like they've shown that they manage credit really well by finally being able to pay this big bill off, but it's very important to keep that card open.
Liz: That's a really good point. We think that we're doing the responsible thing by shutting off access to credit, and it's exactly the opposite, at least in terms of the credit scoring formulas.
Sean: Well, maybe we could turn to some do's and don'ts here because there are a lot of misconceptions.
Bev: The most important thing always is to pay on time. People get focused on these other little tangents, but paying on time is huge.
Liz: That's a really good point. So what can people do to make sure they do that, Bev?
Bev: What I advise people to do, is if you're afraid you're going to forget, then go ahead and automate at least the minimum payment, assuming that you always have that much in your checking account. But that way, even if you end up paying a little bit of interest, you don't see your score tank.
Liz: Yeah, I hear a lot of people that don't want to set up automatic payments, and I was thinking, "Oh, that's ridiculous." But a lot of people do live paycheck to paycheck. So they're really worried about setting up automatic payments because it might go through right when their checking account is on fumes.
Sean: So in that case, I guess it's more important to be regularly and more proactively monitoring what's in your checking account and when your due date is.
Bev: Well, also, if you do pay late, a little bit late is better than a lot late. You're not reported late until you are 30 days late. You may have to pay a fee, but it's not going to hurt your credit score, just your bank balance.
Liz: Yeah. And maybe you can help yourself by putting little reminders on your calendar so something pops up to poke you to say, "Hey, look at your balance, look at your due date. See if it's time to make a payment."
Bev: You can automate that too. You can set up auto-reminders so that you get a text or an email.
Liz: Yeah. I need all the help I can get.
Sean: Yeah. Or you can be like me and develop anxiety around this and just check it every single day. So whatever works for you.
Liz: One thing we should probably talk about is how to monitor all this because there's so many different types of scores. It's really easy to look at one score and think it's this amount, and then you look at another score and you think, "Oh, my score has dropped," or, "Oh, my score has gone up," when actually, they're completely different scores. Can you run through that for us. Bev?
Bev: Most scores are on the same scale and they go from 300 to 850, but there are some scores like bank card scores and auto scores that are on a different scale. And so if you're comparing one to the other, it's like apples to oranges. But even if you're comparing scores that are on the same scale, they don't all weight various factors the same way and your score can be different. It's kind of like weighing yourself in the morning at home, weighing again in the afternoon at the doctor's office, and maybe on some different scales later. Your weight is probably not going to be exactly the same, but if you have a healthy weight one place, chances are you're within a healthy range all the places.
Liz: Oh, that's a great metaphor. That's true.
Sean: So don't sweat the small changes or why you might be a little bit different in one place or the other, just focus on the long-term goals of keeping a healthy credit score.
Bev: Right, Sean, and pick one score and monitor it. You can make yourself crazy if you keep looking at different scores and trying to figure out where you're going because it's not the same score.
Liz: And of course we recommend you come to NerdWallet and take a look at the score that we provide.
Liz: Because that's the way to get it for free, and you can monitor the ups and downs without driving yourself nuts.
Sean: Well, Bev, do you have any other final words of wisdom for Corey?
Bev: One last thing is if Corey has not checked credit reports, do that. A mistake on your credit report can cost you points, so check. And you can dispute mistakes. Sometimes that works out to give you some additional points too.
Sean: All right. Well, thank you so much for talking with us, Bev.
Bev: Sure. Thanks for having me.
Liz: And with that, let's get to our takeaway tips. First, if you pay on time and use your cards lightly, you'll have good scores, no matter which method you use to get there.
Sean: Next, keep credit cards open. It can be tempting to close one once you finally pay it off, but that can actually damage your credit.
Liz:Finally, think about becoming an authorized user on someone else's card, that may both increase your credit age and reduce overall credit utilization.
Sean: All right. And that is all we have for this episode. Do you have a money question of your own? Turn to the Nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD. And you can also email us at [email protected]. And visit nerdwallet.com/podcast for more info on this episode. And remember to subscribe, rate and review us wherever you're getting this podcast.
Liz: And here's our brief disclaimer, thoughtfully crafted by NerdWallet's legal team. Your questions are answered by knowledgeable and talented finance writers, but we are not financial or investment advisors. This Nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstance.
Sean: And with that said, until next time, turn to the Nerds.