Saving Money or Paying Off Debt: Which Is Better for Your Credit?

By June 7, 2018Debt, Save Money

When you’re working on your credit repair, each financial decision you make takes a little more forethought than usual. That’s because you can’t just look at the bottom line for your wallet, you also have to look at the bottom line for fixing your credit.

This is particularly true when you want to improve your credit while better utilizing some of your spare cash. Should you save it in the bank or use it to pay off your debt? We’ll go over the pros and cons of each option so you can figure out a plan that works for you.

Fix Credit by Saving Money

While there are certainly many reasons to pay off your debt, saving money can also have a helpful impact on the credit repair process. The main reason is that it prevents you from having to take on more debt somewhere down the line.

Think about it: if your credit cards are nearly maxed out (which is already hurting your credit score) and a financial emergency hits, what will you do with no extra cash on hand? You’ll probably completely max out the cards, or even worse, apply for new credit cards or payday loans. None of those are ideal choices.

They can, however, be avoided.

Creating an emergency fund keeps you from being forced to make more financial decisions that could harm your future further down the line. Most experts recommend a cash cushion of at least three months of expenses so that you have something to live off of in case you lose your job or have a medical problem that prohibits you from working. If you’re the sole breadwinner for your family or have several children, you might consider saving up to six months of expenses.

Yes, that sounds like a lot of cash. So if you’re just getting started saving up money, try to stash away at least $500. That amount may cover any one-off emergencies, like a sudden vehicle repair or short trip to the hospital.

Improve Credit by Paying Off Debt

Once you have a comfortable savings fund to cover an emergency (or a surprise job loss), you can focus on fixing credit through debt payoff. This can really help improve your credit score in a few different ways.

One way is that paying down debt lowers your debt utilization, which can raise your overall credit score. The more debt you have on each credit line, the more your score suffers. Once you start to pay down your debt, your credit utilization also lowers, which is a plus. In fact, your “amounts owed” can account for a full 30% of your credit score.

Also, if you have a lot of credit card debt, your credit mix can be affected, which is another factor considered part of your credit score. Typically, installment loans like a mortgage, student loan, or even an auto loan are viewed more favorably than credit cards. They’re not as risky since you have more skin in the game when it comes to paying them off. On top of that, having too much credit card debt can place a particularly large toll on your score if you don’t have much of a credit history yet. Either way, it’s a good reason to consider paying down your debt no matter how long your credit history may be.

As long as you’re not at financial risk with minimal cash reserves, paying down your debt can do wonders for your credit. The less you owe, the more you’ll begin to see your credit improve. Plus, early payoffs can lead to substantial savings in interest over the years.

Other Steps to Take for Credit Repair

Saving money and paying down your debt are both smart strategies for repairing your credit. But if you have credit errors on your credit report, your score will only go so high, even with these changes. Credit disputes are a way to get those credit errors permanently removed from your report. However, the process can be time intensive and tedious.

Ovation Credit offers a free consultation so you can find out how our credit professionals can assist you with the credit dispute process. Schedule yours by visiting our site for a free consultation and to get an idea of what negative errors could be removed from your credit report.

Sources:

https://www.thebalance.com/how-much-should-i-have-in-my-emergency-fund-2388353

https://www.myfico.com/credit-education/amounts-owed/

https://www.investopedia.com/terms/c/credit-mix.asp

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