Most people have some sort of debt in the form of mortgages, car loans, education loans, credit card outstanding, personal loans etc. in their names. While undoubtedly debt increases your buying power, it has a direct impact on a number of financial parameters, including your ability to borrow more, the rates you can get on insurance, and of course, your credit score.
The Relationship between Debt and Credit Score
The debt amount, one of the largest components of your credit score, accounts for 30% of the final score. The calculation takes into account your credit utilization, which is nothing but the amount that you have used on each of your credit card limits. The higher the balance compared to the limit, the more it impacts your credit score. Cards on which you have reached or exceeded the limit have the most negative impact on your credit score. If your outstanding loan amount is close to the amount of the original loan, your credit score is also affected, thus it is prudent to keep on making regular loan repayments to bring the balance down. If your debt-income ratio is not healthy, it will pull down your credit score and make it difficult for you to access more loans or credit cards. Consult the many online debt settlement reviews to find out more on credit score calculation.
Debt Repayment Capacity
The way you are able to repay your debt also impacts your credit. If you are able to pay off your balances quickly, it helps to improve your credit score as you credit utilization ratio comes down. However, if you are unable to make the payments on time due to cash flow problems, it can lower your credit score. Also, it is wise to keep in mind that your credit score will take a hit if you opt for debt settlement or file for bankruptcy. It can take an extended time to undo the damage to your credit score because you have got to demonstrate that you have managed to get your finances back on track and are able to handle debt responsibly.
While undertaking credit counseling does not impact your credit score, choosing to consolidate your debt has an indirect impact.The age of your debt that accounts for as much as 15% weightage in your credit score is now lowered. While actions like debt settlement or consolidation do impact your credit score, it may still be worth your while to undertake them so that you can get an opportunity to get your finances in order and repair your credit score over time.
The types of your debt accounts have a 10% weightage in your credit score so it helps to have a diverse basket of debt. However, it is never a good idea to take on additional debt just because you want to improve your credit score. Paying off your entire credit card balance every month is a good way of keeping debt under control.