Debt Impacts Your Credit Score, But Not Always How You Might Think
Key takeaways:
- On-time payments and low credit utilization are two of the biggest factors affecting your credit score.
- Keeping your credit utilization below 30% can help maintain or improve your score.
- Managing debt responsibly through timely payments and careful borrowing supports long-term credit health.
While most consumers carry some form of debt, not all debt affects your credit score in the same way. Your credit score accounts for the amount and types of debt you carry, the percentage of available credit you’re using and whether you’ve made payments on time.
Understanding how credit bureaus look at your debt can help you make informed decisions about borrowing more and paying down what you owe. Your credit score may benefit as a result.
The key components of your credit score
Your credit score is based on five main factors:
- Your payment history (35%). This refers to your track record of paying bills on time, which is one of the most important factors in your credit score. Your payment history includes payments made on credit accounts and installment loans, as well as accounts sent to collections and bankruptcies.
- Amounts owed (30%). FICO research shows that the amount of debt you carry can affect how lenders view your ability to manage monthly payments. This category assesses both how much debt you have and how much of your available credit you’re using.
- Length of credit history (15%). This aspect of your credit score reflects how long you’ve had your credit accounts, with a longer history reflecting positively on your score.
- Credit mix (10%). Your credit mix is the types of credit you currently use or have access to, including revolving and installment accounts. Having a mix of credit types can benefit your score.
- New credit (10%). Your credit score also accounts for how many new accounts you’ve opened. Opening too many new accounts in a short time period can signal higher risk to lenders and negatively affect your score.
Where debt and your credit score meet
Debt affects every part of your credit score, but there are a few areas worth paying closer attention to. First, consider your payment history. Making payments on time is one of the most important things you can do to improve your credit score; this includes payments on debt obligations, such as credit card bills, student loans and mortgages. Even one payment more than 30 days late can diminish your score, and accounts sent to collections can have more severe impacts.
How much you owe on credit cards is another area to consider. Credit bureaus also look at how much of your available credit you’re using. This is called your credit utilization ratio. For example, if you have a $3,000 balance on a $10,000 credit card, your utilization ratio is 30%. A ratio higher than 30% can negatively affect your score, while ratios under 10% can give your score a significant boost.
Finally, debt can impact your score if you take on too much at once. Opening multiple new credit accounts lowers the average age of your accounts, which can decrease your credit score. New lenders also make inquiries about your credit score and report, and those inquiries can have a small effect on your score as well.
Debt decisions that boost your credit score
When it comes to your credit score, debt isn’t always good or bad. Instead, it’s how you’re handling it that makes a difference. Consider the following moves to ensure that your debt doesn’t negatively impact your credit score:
- Keep your credit utilization ratio low. That means monitoring your overall debt, including how much you’ve borrowed via revolving credit lines. It can be easy to increase your credit utilization if you’re spending heavily on a single credit card. Limiting spending is the best way to keep your ratio low; you can also ask your credit card company to increase your limit, which may help lower your utilization ratio, as long as you don't increase your spending.
- Make more than the minimum payment. When possible, make a payment higher than the minimum required by your credit cards. In doing so, you’ll reduce your balance faster — ideally to zero — and at the same time, improve your credit utilization ratio by decreasing your debt. Prioritize paying down your highest interest debt first. That may mean paying more toward your credit cards, which often have double-digit interest rates, or accelerating payments on a car or student loan.
- Don’t close unused credit cards. Once you have paid down high-interest debt, you can keep those unused credit cards open. Doing so ensures you have access to credit and can improve your credit utilization rate (as long as you keep your borrowing to a minimum).
- Automate your installment loans. A track record of paying down installment loans and avoiding late payments will give your credit score a solid boost. Use banking tools such as automatic or recurring bill pay to help you pay on time.
- Contact your loan servicers if you’re struggling. Defaulting on a loan can affect your credit score for up to seven years. If you’re having trouble making payments, ask your lender or loan servicer about reducing your payment to a more manageable amount. Some student loan programs offer Income-Driven Repayment plans, which adjust your monthly payments to align with your income. Investigate these options to help manage your debt and avoid the credit score consequences of missed payments, delinquency or default.
How Northwest Bank can help
Successfully managing your credit accounts and debt is key to building a solid credit score. Connect with us to learn how our digital banking tools, checking and savings accounts can set you up for financial success.
