July 9th, 2010

What’s the Deal with Debt and Your Credit Score?

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It’s a love-hate relationship. When debt crops up on your credit report, good debt management can contribute to a great credit score… or mishandled debt can also damage your credit score.

If you are a credit-savvy consumer, you know that total debt is one of the key financial components that go into calculating your credit score. While debt isn’t necessary to a good credit score, having credit is necessary, and borrowing any kind of credit–whether its a credit card or a mortgage–can potentially accumulate debt. Ultimately, it is how you deal with your debt that lenders consider as a reflection of your creditworthiness.

Here are a few tidbits on the love-hate relationship of your debt and your credit score.

  1. More debt isn’t always a bad thing. Not kidding. Good credit habits include minimizing revolving debt, such as credit card bills that you should pay off each month, while balancing installment debt, such as student loans or mortgages that keep you in debt for years. Also, having a mix of credit, from mortgages to loans to credit cards, is important in a credit score and demonstrates responsible credit management. Surprisingly, Credit Karma data shows that those with $5,001-$49,999 in debt averaged a credit score of 640, while those with more than $150,000 in debt averaged a higher credit score of 701.
  2. All kinds of debt can affect your credit score. Did you know your medical bills, utility bills, and even your cell phone bills can damage your credit score? Any bill or loan you default payments on can be sent to a debt collection agency and will become unpaid debt that stays on your credit report that reflects in your credit score. If you find out from your credit report (or ceaseless phone calls from a debt collector) that you have unsettled debt, contact the collection agency and negotiate payments on your debt to settle as quickly as possible. After the debt is settled, check your credit report to make sure the debt is listed as “Paid in full” or “Settled”.
  3. Prioritize your debt. Healthy credit habits include dealing with debt as promptly as possible by prioritizing your debts. Installment debts stick with you for awhile, so adding money to your minimum monthly payments will save you in interest in the long run and pay off your debt sooner. For your revolving debt, first pay off the cards with the highest balances or highest interest rates (or both). These cards are costing you the most by piling highest interest on top of your principal debt, so get rid of them as soon as possible. Pay off first whatever debt is costing you the most money, and use the freed-up, extra money to tackle the next card.

Love it or hate it, debts are inevitable in your financial life, especially if you plan to take out a loan, buy a home, or use a credit card. But heed these insights and maintain good credit habits so that one day you and your healthy credit score can live happily ever after.


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