Your credit score is one of the most important pieces of information in your financial history. It is a number that is used to “rate” you and determine how “creditworthy” you are. You may not get a loan if your credit score is too low, or you may get poor terms and pay a higher interest rate. Employers, insurance agents and even cable companies look at your credit score.
What Determines Your Credit Score?
One of the most important factors in determining your credit score is your debt. Here are some of the ways that debt affects your credit score:
Debt to income:
The credit score takes into account how much debt you have with relation to your income. If you have a great deal of debt, it may show up as unfavorable in your history, and affect your credit score.
Amount of available credit:
When you have debt, the amount of credit available to you goes down. For example, if you have a credit card with a limit of $1,500, and a balance of $1,300, you only have $200 of your $1,500 available. Outstanding debt is a very large portion of your credit score: 30%. Fully a third of your credit score is dependent on your available credit. It is best to avoid consumer debt altogether, but if you want a better credit score, it is a good idea to reduce your debt so that it is at only half of what you have available to you.
Inquiries into getting debt:
Credit inquiries have an affect on your credit score as well. Even before you actually borrow the money, debt affects 10% of your credit score. When you apply for a loan (including a credit card), a look into your credit history is made. This affects your credit score because the fact that you are looking for debt can be worrying — especially if the first two items are already a concern.
Making debt payments:
The largest consideration in your credit score is your debt payment history (35%). Do you pay on time? Do you always pay at least the minimum? Your credit score will take into account your payment history, and a reported late payment or a missed payment, on your debt obligations can have a big negative impact.
Because the credit score is designed to let lenders and creditors know how reliable you are when it comes to repaying your obligations, it is no surprise that debt is a huge factor. Indeed, the credit score is almost entirely designed around how you handle your debt.
Miranda Marquit edits information on debt consolidation for DestroyDebt.com. She also writes about finances for the AllBusiness Personal Finance Corner.
Photo Credit: Kiên Phạm