How Your Debt And Credit Score Can Both Be Useful

You might think that debt is a bad thing – and if it gets out of hand, it certainly can be a problem.   But if you are in debt you can actually turn this lemon into a nice refreshing glass of lemonade.

That’s right.  If you play your cards right (explained below) you can harness your debt in a way that actually saves you money.

To understand how this works,  let me point out that your debt and credit score are inextricably intertwined.   If you structure your debt wisely, you can increase your credit score.

That in turn will have lenders lining up to offer you credit at very low (or no) interest.   Have I got your interest yet?  Good.  Let’s continue by talking about the fascinating world of credit utilization.

Credit Utilization

Credit utilization is simply the amount of debt you have compared to the amount of credit you have available.

So if you owe $2,000 and have $10,000 available – that means you are utilizing 20% of your available credit.  That’s a decent credit utilization and it will likely help you elevate your credit score.

If you owe $2,000 on combined credit cards but only have $2500 available credit, your credit utilization is 80% Kapish?

Obviously, the higher your credit utilization, the lower your credit score.  Here’s why:

If you are a creditor and see that a borrower is getting close to maxing out his total credit, you start to get worried.

That’s because such a borrower has a higher risk of being unable to pay you back. What happens when the borrower actually maxes out?  How are they going to pay their bills?  The simple answer is, they probably won’t.

If you are using a big percentage of your available credit, your credit score is probably already suffering.

But here’s the good news; if you can somehow increase your available credit (without actually using the credit line) you’ll drive your utilization rate down and therefore push your score into a strong credit score range.

This is important because your credit utilization accounts for about 30% of your credit score.

How do you lower your credit utilization?

Start by not canceling a credit card when you pay off your debt. If you have a $3,000 limit on one card, and a $2,000 limit on another (total of $5,000), you can damage your credit score by canceling a card. Of course you want to get out of credit card debt just don’t cancel the card.

Let’s say you pay down your $2,000 card, but you still owe $2,500 on your $3,000 card.

If you keep both credit card accounts open, your credit utilization is 50% (2,500/5,000).

However, if you cancel the $2,000 card in celebration, your credit utilization immediately changes. Now, it’s 83.3%. Ugly.

Canceling that credit card, instead of helping your score, has actually hurt it.

Besides holding on to old credit cards with 0 balances, you can also open up new credit lines or try to get your existing cards to increase your credit limit.

Don’t go crazy opening new credit cards because that can sometimes hurt you out of the gate.   This is more of a long-term structural contribution more than an immediate fix.

But if you don’t have many cards now, first try to increase the credit line and next, consider opening up one more credit card.   Overtime, this will help your credit score increase.

Be Mindful Of What Kind of Debt You Have

To a lesser extent, the types of debt you have also affect your credit score. The types of debt you have account for about 10% of your FICO score.

A home mortgage loan is viewed more favorably than a payday loan. Additionally, having a mix of revolving credit loans (like credit cards) and installment loans (like auto loans) can be more beneficial than having just one type of loan.

Also, be aware that you gain a slight credit score edge by having a credit card from a major issuer, rather than from a department store. While type of debt doesn’t have as large an impact as your credit utilization, it still matters.

You can use all this information to your advantage.   First, if you have a ton of credit card debt, consider refinancing your home and paying the cards off (while keeping them open).

Another option of course is to use and equity line of credit.  Still another idea is to get your friends and family to refinance this debt.

Also, stop using your store-issued cards and use those cards issued by the major issuers instead.

Your Takeaways

Do everything you can to erase your debt.   One way to do that is to lower the interest your credit lenders charge you for the money you owe them.

You can get lower rates if you increase your credit score and you can increase your credit score if you structure your debt correctly.

Try to decrease your credit utilization by holding on to zero-balance cards, getting your existing lenders to increase the credit lines, and as a last resort, open new lines of credit.

Also, be mindful of who you owe money to and how that impacts your score.   Focus on the major players in the credit card world rather than department store cards.

Try to either pay off your debt fast or refinance it with a new mortgage or asking your friends and family to help out.

If you are in debt, please take these two steps.

You credit score influences how much you pay in interest, whether you get the loan you want, and even your insurance rates.

How much debt you have, and the kinds of debt you have, matter in credit scoring, and can mean the difference between being approved with good rates, and having your loan application rejected.

P.S.  The first step to improving your credit score is to know what it is. Here’s how to get a free credit score without using a credit card if you don’t already know your score.