How debt affects your credit score

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How debt affects your credit score
1 year ago
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You pay all of your accounts on time, you have a long credit history, and you have no bad debts in collections. Why then, is your credit score not higher than it is? If you meet the criteria for good credit, yet cannot seem to get your credit score into the ?œexcellent??range, your high debts may be to blame.

The Amount You Owe
The amount you owe to your creditors is a crucial factor in determining your credit score. Only your payment history has a greater effect on how your credit is scored. Because of this, it is important to keep your debts as low as you possibly can.

Unfortunately, if you owe a mortgage debt or are still making payments on a vehicle, the amount you owe may be unreasonably high. Lucky for you, the FICO credit scoring formula takes this into consideration. Loan debts are categorized as ?œinstallment??debts. This means that borrowers are required to pay off the amount owed over a set period of time in regular installments. Installment debt is normal and beneficial for your credit. It?™s high revolving debts that can hinder your credit score.

High Revolving Debts Can Hurt You
A revolving debt is any debt on an account with a spending limit. You may make purchases until you reach your spending limit. When you pay off your purchases, you can recover the percentage of your spending limit that was inaccessible before due to outstanding debt. Credit cards and home equity lines of credit are two common examples of revolving debt

When you charge as much as your creditor allows, you do not leave yourself any financial wiggle room. In addition, maxing out a credit limit makes it appear to both lenders and the credit bureaus that you may be having financial difficulties. Because of this, individuals who charge a high amount on their revolving accounts are more likely to be turned down for credit or pay higher interest rates on future lines of credit and loans.

Credit Scoring and Debt
When your credit is scored, the credit bureaus take your debt-to-limit ratio into consideration. Your debt-to-limit ratio is determined by measuring the amount you owe against your available credit limit. A low debt-to-limit ratio shows good debt management skills and will result in a higher credit score, whereas a high debt-to-limit ratio is a warning sign of financial instability and can actually cause your credit score to drop.

By paying down your high revolving debts and lowering your debt-to-limit ratio, you can push past the glass ceiling that is preventing your credit score from climbing into the range you want. For years the experts have recommended keeping your debt-to-limit ratio at 30% or lower. While this may protect your credit score from damage, it will not help you accrue additional points. In order to ensure that your credit score climbs, keep your debt-to-limit ratio at a low 10% or less. Not only will your interest charges be much less, but you may finally see a positive change in your credit rating.
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