Credit score plays a significant role in a person ability to pay out debts. For instance, having a good credit score represents the right credit decision. It makes creditors more confident with the person ability to repay their credit balance in the future as agreed. It is a tool commonly used by lenders, including credit card companies, to determine whether or not to offer you a loan and the terms of the offer. In this regard, it is essential to build a strong credit score, which will enhance a person opportunities to access financial capital.
The rationale of Investing and Paying The Debt
To build a positive credit score, it is essential to repay the debt as per the unexpected amount received of $5000. In this scenario, it would make sense if a person has a credit card debt consider paying down the debt rather than investing (Lee & Lee, 2016) . For instance, if the credit card balance attracts higher interest rates, the repayment amount is likely higher. Therefore, it is vital to consider paying it sooner than taking up new investment. Since credit score depends on how well a person can repay their loans, clearing the outstanding debts will have a positive impact on the credit score of an individual.
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More so, it also depends on the risk that an individual attaches to the returns. For instance, it the cost of acquiring credit or debt is higher compared with the initial returns that a person expects to receive from an investment project. They should consider paying off the debts first before carrying out investments (Sjoblom, Castello & Gadzinski, 2019) . Thus, it will have an impact on their credit score because the decision to invest depends on two factors, which are tax rate and the risk. For example, if a person acquires a mortgage which has 4% interest, marginal tax bracket at 20%, and an investment return of 5%, the income tax would reduce investment returns to 3%. Thus it would still build a negative credit score to the investor.
To build a good credit score, it is essential that a person prioritizes which debts to be paid first. In this case, the costliest debts should be considered first. For example, having a credit card debt which is 10% APR, a motor vehicle loan at 5%APR and a home loan at 3% APR. It is vital to pay off the credit due first, then consider repaying the motor vehicle loan and finally consider repaying the home loan (Lee & Lee, 2016) . It will have a better rate of return, putting $5,000 towards repayment of debts than what it would yield if a similar amount were placed in the investment, which has a 3% rate of return.
Conclusion
Deciding on whether to put the cash in a new investment or repay the debt have a significant impact on the credit score of an individual. For instance, opting not to repay credit balances attracts penalties, which negatively affects the credit score. Therefore, to build a better credit score requires the elimination of all expenses that will directly impact your income. High-interest credit debt running shows that repaying the debts makes more sense than investment. However, individuals should ask themselves how much risk they can tolerate and which will have a positive impact on their credit factor. Paying off the debt will reduce the risk of unforeseen occurrences as a person is likely to build a strong credit score.
References
Lee, Y., & Lee, W. (2016). The Effect of Managerial Ability on the Financial Score and Credit Score. Korean Journal Of Accounting Research , 21 (5), 1. doi: 10.21737/kjar.2016.10.21.5.1
Sjoblom, M., Castello, A., & Gadzinski, G. (2019). Profitability vs. Credit Score Models—A New Approach to Short Term Credit in the UK. Theoretical Economics Letters , 09 (04), 1183-1196. doi: 10.4236/tel.2019.94076
