What is the Relationship Between Credit and Debt
September 17, 2019
Your credit score is a representation of how financially responsible you are, both now and in the past. It’s why lenders and creditors will use your credit score to determine how big of a risk you are, which is why it affects whether you’re able to qualify for a loan or for credit and what the terms will be.
A lot of people assume that their credit score is the result of any debt that they are carrying. While having a significant amount of debt can certainly hurt your credit score, not all debt is actually bad debt. Additionally, your credit score is dependent on numerous other factors as well. The following is a rundown of exactly how debt and credit are related.
How is Your Credit Score Determined?
While the amount of debt you carry can hurt your score, it’s based on how much credit you have. It’s called the debt utilization score. If you have a significant amount of debt, but it only takes up 30 percent of your total credit, then it may not actually have as big of an impact over your overall score as you think. However, if you have a small amount of debt but it takes up a large percentage of the credit you have available, it will hurt your score more.
Additionally, debt is not the only factor used to determine your overall credit score. Things like how many credit cards you have and how many you’ve applied for can affect your score. So will late payments or unpaid debts that went to a collection agency. All of these blemishes will remain on your credit history for at least seven years and will affect your credit score as a result.
Can Having Debt be a Good Thing?
It’s actually not bad to have debt. First of all, the longer your credit history is, the better. If you’ve never taken on any kind of debt, you won’t have much of a credit history, which can actually hurt your score. Secondly, it’s good to have a mix of different credit on your credit report. For example, having a credit card with a small balance on it is not as good as having a credit card with a small balance on it as well as a personal loan that you’re paying off. By having debt, you’ll also have a history of making payments on time (as long as you do this, of course). On-time payments show creditors that you are financially responsible.
Avoiding debt is impossible. Lenders will actually prefer that you’ve had some debt at some point in your life because it shows them that you know how to handle the debt you take on. If you’ve never had any debt, they will feel less at ease about approving a loan.
How Should You Balance Your Credit and Your Debt?
Generally speaking, you’ll want to have a mix of revolving credit and installment loans on your credit history. As long as you manage your credit cards and your loans responsibly, you’ll be viewed as less of a risk than borrowers who do not have these things. While other factors are taken into consideration when determining a credit score, you should try to keep your debt-to-credit ratio under 30 percent. Anything under 30 percent is good. If you’re over 30 percent, you should work on paying down your debt.
Understanding the relationship between your debt and your credit can help you manage your debt and utilize your credit more effectively and more responsibly. Everyone has debt, it’s a fact of life today. How you handle it is important, and we can help. You have good credit, a good job, and you’re paying your bills. Maybe it’s time to pay off your debt for good and look forward to a future with financial freedom. Your debt can feel suffocating, but we can help you find a solution. For expert advice on how to handle your debt, contact us at Safe Money Partners today.
By Jeff Mohlman