Building Credit and Getting Out of Debt: Practical Steps to Improve Financial Standing

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Debt affects your financial health—interest and penalties add up. It also affects your mental health since it can be a profoundly stressful experience. If you’re in debt, you’ve probably wondered how to recover financially, and without ruining your credit.

Well, good news. Getting out of debt can actually help you build credit, for two reasons:

     1. Regular, on-time payments look great to potential lenders because they are one of the primary factors in calculating your credit score.

     2. Another substantial chunk of your credit score comes from your utilization rate, so you should strive to keep your credit use far below your limit.

That means you can simultaneously build credit and get out of debt.

Maintaining a good financial standing can help get you approved for loans and lines of credit quickly and with low-interest rates, saving you money in the long run.

So there’s no time like the present to improve your financial wellness and get back on track.

Step One: The Evaluation

How can you get out of debt and improve your credit score? It begins with a holistic overview of all your debts and what they involve. Here’s what you need to do:

  • Pull all your credit reports from the major credit bureaus to know where you stand. This shouldn’t take more than a few days.
  • Note your current debts, their interest rates, and the minimum monthly payments and due dates.
  • Add all these payments together. This will show you what it will cost monthly to ensure your debt doesn’t worsen.

Of course, you should always strive to pay more than the minimum amount; the minimum won’t cover much more than the interest, which means you could be climbing the debt repayment mountain for a long time.

Plus, paying down your debt—and always paying off your credit card balance in full—does wonders for your credit utilization rate, which you should keep below 30%. A history of punctual payments also adds to your credit score.

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Step Two: The Restructure

Determine whether debt consolidation is right for you. One of the best ways to consolidate debt without hurting credit is to take out a loan and use it to pay off all your outstanding balances in one fell swoop. But remember:

     1. Find lenders with low-interest rates. Once you only have one low-interest debt to worry about—instead of lots of high-interest debts—you’ll have more cash to repay.

     2. If you’re applying to multiple lenders, try to do so simultaneously. Otherwise, every hard inquiry on your credit report will leave a small dent in your credit score.

     3. Even after you’ve paid off your credit cards, keep them open. Your average age of credit contributes to your score.

Consolidating debt can save you money and simplify your payments. It can also improve your credit score by diversifying your credit mix.

Another way to restructure debt is with a balance transfer credit card, which can consolidate multiple credit card balances with a lower APR (sometimes even 0% for a set amount of time)—though there could be a transfer fee of about 2% to 5% of the total you transfer.

Step Three: The Strategy

If you can’t consolidate your debt, consider separating it and creating a strategy for paying it off. Try these two proven approaches:

  • The debt snowball method: pay off your smallest debt first, and then move on to the next one. This builds momentum and frees up money for larger debts.
  • The debt avalanche method: focus on paying off high-interest debts first to save the most money. Once paid off, move to the next highest interest. Then use the money saved to pay off smaller debts.

If you want to improve your financial wellness when in debt, the snowball and avalanche methods can help. So can the 50/30/20 rule, where you carefully budget to spend half your income on necessities, a third however you choose, and you dedicate the rest to paying down your debts.

Getting out of debt leads to good financial standing, and that can open all sorts of possibilities for your future. And if you need help navigating the path out of debt, our local experts are here to help.

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