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There are two main types of credit accounts: revolving credit and installment credit. Your credit card falls into the revolving credit category, and things like your mortgage, car and student loans fall into the other.
Having a mixture of the two is important for your credit score, but making sure you pay off both kinds of debt is even more crucial for a healthy financial future.
While we recommend keeping up with payments on both, there is general guidance to follow when you're deciding which to prioritize paying off first.
Below, CNBC Select breaks down which debt is better to pay off first and what to look out for if you're having trouble keeping up with your balance.
Having both installment loans and revolving credit will help your credit score, as long as you pay the bills on time. Both types of credit illustrate to lenders that you are able to borrow varying amounts of money each month and consistently pay it back.
But if you're struggling to decide which to pay off first, focus on your credit card debt.
Experts generally agree that the most basic rule of thumb when developing a long-term debt pay-off plan is to ask yourself a simple question: Which debt is costing you more? If you carry a balance on your credit card from month to month, that ballooning balance is likely costing you much more than your installment debt.
This approach of paying off the balance with the highest APR first and then working your way through all your debt from highest to lowest APR, is known as the "avalanche" method. With this method, you end up paying less overall in interest.
As an example, let's take a look at the current interest rates on credit cards (revolving credit) compared to student loans (installment credit).
The average credit card APR is 16.61%, according to the Federal Reserve's most recent data. That's more than six times higher the 2.75% federal student loan interest rate for undergraduates for the 2020-21 school year. Even the federal rates for unsubsidized graduate student loans (4.30%) and parent loans (5.30%) don't come close to credit card interest rates.
Tackling your credit card debt first will also give you a better shot at improving your credit score. Revolving credit is highly influential in calculating your credit utilization rate, which is the second biggest factor (after payment history) that makes up your credit score.
Experts generally recommend using less than 30% of your credit limit. As you pay off your revolving balance, your credit score will go back up since you are freeing up more of your available credit.
Americans carry an average $6,194 credit card balance, so you're not alone if you have credit card debt.
But there are credit cards out there that help you avoid racking up interest when you do have a balance that goes unpaid.
CNBC Select ranked the best zero interest credit cards and many offer balance transfers. Here are a few of our top choices:
- Citi Simplicity® Card
- U.S. Bank Visa® Platinum Card
- Citi® Double Cash Card
- Wells Fargo Platinum card
- Wells Fargo Cash Wise Visa® card
- Capital One® SavorOne® Cash Rewards Credit Card
- Chase Freedom®
Most 0% APR credit cards require having good or excellent credit to qualify, so make sure you check your credit score before applying.
When prioritizing paying off your debt, start with the balance that has the higher interest rate (likely your credit cards) and go from there. No matter what type of debt you'll be dealing with, though, the most important factor is that you pay your bills on time.
Information about the Wells Fargo Cash Wise Visa® card, Citi Simplicity® Card, Capital One® SavorOne® Cash Rewards Credit Card, and Chase Freedom® has been collected independently by Select and has not been reviewed or provided by the issuer of the card prior to publication.
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