MONEY CLINIC: Which debt should I pay off first in order to improve my credit score?

There's good, bad and ugly debt. Make sure you know which is which.
There's good, bad and ugly debt. Make sure you know which is which.

A Fin24 user wants to know whether paying off a car loan or credit card will make her credit score 'look better'.

She writes: 

Which debt should I pay off first? Which makes my credit score look better? Car loan, or credit card? 

Tessa Verwoerdt, Head of Department in Money Solutions at Bayport Financial Services responds:

Car loan, or credit card? 

The two products are created for different purposes, vehicle finance being a secured loan for buying a vehicle on credit, and credit card being a revolving loan meant to give you easy access to cash when you need it. You cannot compare the two products like for like. The client should rather get the designed product, which is vehicle finance, in this case.

Which makes my credit score look better? 

When it comes to improving your credit score, the key aspect is servicing your debt on time regardless of the product. Based on that fact, if the exposures/amounts are the same, your credit score should be affected the same way.

Which debt to pay off first? 

The answer to this question is a combination of many factors, including total cost of credit (comprising interest rate, admin fees, initiation fees and/or credit life insurance which differs depending on product) and exposure/amount. If the total cost of credit and the amount are the same, there wouldn’t be much of a preferential choice between the two. If there are differences, start by staying off the debt with the highest cost of credit.  

Since interest rates are charged on outstanding balance, if the interest of the two products are the same but the exposures are different, the higher exposure will attract to a higher absolute amount (the total interest rate charged) being paid towards interest rates. The most prudent thing to do would be to identify the product with the higher absolute interest amount and pay off that first. However, there are various scenarios to answer this question, and it depends on your personal circumstance. 

Compiled by Allison Jeftha. 

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