My Debt Relief Plan

How are debt and credit ratings related?

December 17th, 2007

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Are you unhappy with the score you found on your free credit report?  There are many factors in your debt that may be affecting your credit rating.  Credit and debt go hand-in-hand, it is only natural to owe money. 

The amount you debt you carry, and the type of debt you carry, can greatly influence the numbers exhibited on your credit report.  So how exactly does debt affect your credit score?  The two most important factors, the type of debt, coupled with the debt to credit ratio, are significant in the relationship between debt and credit ratings.

The Type of Debt 
Holding a diverse range of debt (credit card, auto loan, mortgage, etc.) is actually a good thing when it comes to calculating your credit score.  Lenders do not like to see people with too many eggs in one basket.  Consider the benefits and shortcomings of each type:

Credit Cards – Credit cards are a tricky form of debt to deal with.  On one hand, having a longstanding history of timely payments (higher than the minimum due, or better yet, the full balance) strengthens your credit score greatly.  Conversely, if you constantly transfer balances from card to card, you can hurt your score greatly.  Having multiple department store credit accounts with balances is another aspect that is damaging on a credit report.

Mortgages – Mortgages give you one of the most valuable commodities which lenders look at – a long payment history.  If you buy a house, you will probably be making payments for many years.  If pay in a timely fashion, it will establish a solid record and add additional points to your credit score.

Utility Bills – Regardless of your housing situation, as a renter or home owner, you will pay utilities on a regular and on-going basis. While these sometimes miniscule payments seem unimportant, in the long run, they are an important part of your credit score.  Usually, the factor surrounding utility bills that will affect you the most is whether or not you pay on time.  It is easy to forget payments, or send them in at the last minute, and in the long run, this will be negative for your credit score.

The Debt to Credit Ratio
If you hold a credit card with a $500 limit, and you carry a $499 balance, it means that you are utilizing 99% of your available credit.  This available credit limit, in relations to your available balance, is known as the debt to credit ratio; and having one that exceeds 50% is not favorable in the eyes of most lenders.  If the same $499 balance was carried on a card with a $5,000 limit, the debt to credit ratio would only be 10%. This is a much more impressive number in the world of credit reporting.  Carrying high balances on your credit cards will lower your credit score, especially if you have multiple cards with very high balances.  

Consider what types of debt you are carrying, and how the debt is allocated (i.e. if it is all on one credit card, or all in past due utility bills).  Look for a careful balance between these areas, and you may start to see improvements in your credit ratings. Also, many of the free credit report offers found online include tools to calculate and monitor these items. For a more simplified look at your reports, visit www.annualcreditreport.com.

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