Credit card or car loan: Which to pay off first?

Q: My husband and I recently got our tax refund of about $5,000. We have a car loan with about $5,000 remaining and about $3,700 in credit-card debt.

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Which one would be better to pay off? We are hoping to purchase a house next year and want to improve our credit score.
— Christine, Pennsylvania

A: Hi, Christine. Thank you for writing.

My guess — and without seeing your credit report/score, it is a guess — is that you’d be better off paying down the credit cards.  That said, in terms of your credit score, I am fairly certain that neither of these loans (because they’re not that large) is hurting your rating very much, if at all. 

To be sure, though, the best thing you can do for yourself is to spend a little bit of that tax refund on pulling up your credit score.  You can get scores from all three bureaus (plus credit reports) at www.myfico.com — and they’ll come with a report that tells you what you can do to boost your score. (There is a charge for these services.)

If your score is actually pretty good (and anything over 660 is pretty good), I’d then look at which of these debts is costing you the most money and use the money to pay that debt down. 

If it’s the credit cards and you manage to wipe the slate clean, do not — I repeat, DO NOT — close the accounts.  Doing this will lower your score at a time when you definitely don’t want that to happen. Just put the cards in a drawer or some other place where they don’t present temptation.  

Q: Which is better, putting more money toward credit cards to pay them off or putting more money into a savings account?
— Lindsey, New Mexico

A: With interest rates where they are right now, putting more money toward credit cards is going to be your better bet.  That’s because you have to look at the interest rate you’re paying on your cards as the return you’re getting on your money. 

For instance, if you’re paying a typical 14 or 15 percent interest on your credit cards, that’s more than the likely 2 to 3 percent you’re earning on your money when it sits in a savings account. 

That said, the process of getting out of credit card debt will be MUCH easier if you have some savings. 

Why? Say you’re making great progress paying down debt, saving nothing, and the transmission goes on your car.  What happens?  You put the new transmission on your credit card, which puts you right back where you started paying off debt.  You’re demoralized and it’s tough to get going again.

But, if instead, you had a small savings account you could use for emergencies like this, you’d be able to continue making progress.  

So, put most of your money toward paying off the credit card debt, but make sure to put a small amount each month into savings for unexpected stumbling blocks.

Jean Chatzky is the financial editor for “Today,” editor-at-large at Money magazine and the author of “Talking Money: Everything You Need to Know About Your Finances and Your Future.” Her latest book, "Pay It Down: From Debt to Wealth on $10 a Day," is now in bookstores. Copyright ©2005. For more information, go to her Web site, www.JeanChatzky.com.