How Does Debt Affect Your Credit Score?

As we all know, debt impacts on our lives in many different ways. It of course not only affects your spending ability, but also has direct ramifications on your credit score. The consequence of a bad credit score means that it may be difficult to get a good insurance rate and to borrow money if needed.  So how is your credit score calculated? And how does debt affect it?

The amount of debt you are carrying (whether it be revolving, installment or open) is an extremely important part of your credit score. In fact, it makes up 30% of it. In order to calculate your credit score your credit utilization is analyzed; this is the ratio between your credit card balance and limit.

This means that if you have a high limit in comparison to your credit score, your utilization is damaged.  The worst of all is if you have maxed out or over-the-limit cards. Additionally, your score is also affected by how close the balance of your loan is to the amount originally borrowed; if you pay your loan efficiently it has a positive impact on your credit score.

To sum it up, having a lot of debt – notably high credit cards – has a negative effect on your score, which in turn means you can have issues when it comes to applying for new credit cards and loans.

Of course, taking out loans/mortgages is often an unavoidable part of life; it’s how you handle your debt that is important. If you pay off your debt promptly it helps to lower your utilization. If you can’t manage it, for example you miss your monthly payments, then your score will be damaged.

If the situation becomes even more dire, you can choose to become bankrupt or take out a long-term debt settlement plan. If you choose this path, then your credit score can suffer for some time in the future, however depending on your situation this option may be worth considering.

Another option is debt consolidation/credit counseling.  The good thing about these two options is that they have no direct relationship with your credit score.  However, if you opt for debt consolidation, you may be penalized for creating an account which lowers your credit age.

When it comes to debt and your credit rating although some solutions may cause your score to suffer, they could be the best option for your situation.