These days, your credit score (also known as your FICO score) can affect everything from where you live to the kind of car you drive to the job you may obtain.
Credit scores are calculated based on the information in your credit report. As a general rule, you can expect the following factors, weighted in order of importance, to influence your score:
- Your payment history: 35%
- Your total debt: 30%
- Length of your credit history: 15%
- New credit: 10%
- Types of credit: 10%
As you can see, your total debt has a big impact on your overall credit score. The only factor that carries more weight is your record of making on-time payments.
When it comes to debt and your credit score, however, it’s not necessarily your absolute amount of debt that matter. Revolving debt is the real factor here; and for the most people, that means credit cards.
If you have several credit cards and are close to limit on each of them (what is known as high credit utilization ratio), this can drag your score down. Why? Because creditors worry that since you’re using most or all of your available credit, you’re financially stretched.
How Much Debt Is Too Much?
Generally, using more than 30% of your available credit is a red flag. If you have a high balance on one card, you may be able to boost your score by transferring some of that balance to another card that has little or no balance. Another strategy for improving your credit score is to call your credit card company and ask them to increase your credit limit, thus decreasing your total credit utilization.
Having a lot of debt can lower your credit score, sometimes significantly; but the real credit-score killer is when a debt moves to collections. This happens when you fail to make multiple payments on a debt, and the owner of a debt transfers it to a collections agency.
Reduce Your Debt, Improve Your Credit Score
Fortunately, reducing your debt is one of the easiest and fastest ways to improve your credit score. If you expect to apply for financing (such as a home or car loan) in the near future, check your credit score now. If it’s not where you’d like it to be (700 or above is a good target number), start getting aggressive about paying down credit cards or other loan balances. Within a few months, you should boost your score and may qualify for a better loan. As you pay off credit card debt, don’t automatically close those accounts, however. You want to keep your available credit high, so keep those paid-off credit cards active.
And there’s one more catch: Having some debt may actually be a good thing. Not using credit cards at all (even if you have open accounts) means that a credit scorer can’t evaluate your ability to manage debt and make payments. Using your credit card for some purchases and then paying off the balance in full every month can boost your score.
The bottom line: Having a lot of debt can affect your ability to get new credit, qualify for home or other loans, and make the loans you do qualify for more expensive. If you have questions about debt and your credit score, please call to discuss.