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How debt can affect your credit score
In this article
Is yourlower than you want it to be and you’re wondering why? Many factors can impact your credit score, but if you have a lot of debt, that could have something to do with it. Here are some ways that debt can affect your credit score.
We all know that we should try our best to make our payments on time. That one is obvious. However, one of the less obvious ways debts can affect your credit score is something called credit utilization. Credit utilization is just a fancy way of saying how much of our available credit that we’re using. The debt that’s factored into credit utilization is revolving debt. This is any debt that you can borrow, repay and reborrow. The most common examples of revolving debt include home equity lines of credit (HELOCs), unsecured lines of credit and of course,.
It can’t be overstated the importance of your credit utilization. It’s the second most important factor when it comes to your credit score. It accounts for 30% of your credit score.
If you have too much debt, it will impact your utilization, resulting in a lower credit score. You should try to never let your balances exceed 50% of your credit limits. Ideally, you want to aim to keep your balances below 30% of your available credit. That means if your credit card has a $5,000 limit, you’ll want the balance to be no higher than $1,500 at any one time.
If you have regular missed payments, that’s when it can start to really affect your credit score.
Missed payments are the single biggest factor that impacts your credit score. The more missed payments, the more it could drag down your credit score. Likewise, the more delinquent the missed payments, the more it could negatively impact your credit score.
If you get into a situation where you have debt that you can’t keep up with, that debt can be sent to collection agencies, which can further hurt your score.
It’s best to avoid a situation like this by always making your payment on time. If you can’t afford to make the full payment, at least always make the minimum payment to keep your credit score in good standing.
This is one of the ways you can improve your credit with debt.
Banks have the 2-2-2 rule. Ideally, a lender wants to see that you have at least 2 credit accounts open for at least 2 years, with at least a $2,000 credit limit each. You may still be able to borrow money without fully meeting the 2-2-2 rule, but this is still something to aim towards when you build credit.
There’s a point where the number of credit cards has diminishing returns. Having too many – any more than four or five credit cards – can make it harder to keep track of your payments which could bring down your credit score. Keep that in mind the next time you’re offered a new credit card in exchange for a discount on your next purchase at a retailer.
Banks want to see regular payments and decreasing balances. If you’ve had credit card debt for months that never seems to go away, you could have more difficulty borrowing money. Banks could be worried that if you can’t handle the debt that you already have, how are you supposed to handle any new debt?
Also, the type of debt matters. Banks would much rather see mortgage debt than credit card debt. That’s because mortgage debt is generally considered good debt, while persistent credit card debt is seen as more risky because it’s higher interest. You should aim to have more good debt than bad debt (within reason). This can help you build credit and help your credit application have a better chance of approval.
Only borrow what you can afford to repay
Before swiping your credit card, think about how you’ll repay it. Swiping your credit card is easy. Paying off your credit card statement when it comes in the mail is a lot harder.
Pay off the highest interest debt first
If you have debt, a good strategy is to focus on paying off the highest interest debt first. By paying it off, you’ll improve your monthly cash flow and save on interest. Of course, make sure you keep making the minimum payments on all your other debts to keep your credit score in good standing.
Tassie heads up ClearScore Canada. She lives in Toronto with her husband and two young boys. In her free time, she can be found at the family lake house or playing ball hockey.