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How Does Debt Affect My Credit Score?

Sponsored by Northwood Asset Management Group

Your credit score is an important part of your financial health; healthy credit makes your financial life easier. Not only does it make the process of borrowing money easier, but it also opens the door to lower interest rates which make borrowing money cheaper. It determines your access to credit and influences the interest rates that you are offered when you apply for credit cards, loans, and more. People rely on credit scores to make purchases and financial decisions. 

So the big question is, how does debt affect your credit score?

Our goal in this Money Chat is to help you understand the basics of credit scores, how debt affects your credit score, what can hurt your credit score, how to improve your credit score, and ways to build credit if you don’t have any. 

What Is a Credit Score?

Before we talk about what affects your credit score, let’s review some credit score basics. Your credit score is a number between 300-850 that represents your creditworthiness, or a measure of a borrower’s risk to a lender. It is calculated using the information in your credit reports and the higher the number, the better the credit score. A higher credit score indicates less risk for lenders and a lower credit score indicates a higher risk. Borrowers with higher credit scores are more likely to be offered lower interest rates while riskier borrowers with lower credit scores are more likely to be denied credit or receive a higher interest rate.

It is recommended that individuals use a free resource such as to review credit report information regularly to make sure it is accurate. Take the time to review your credit history with each of the 3 major credit bureaus (Equifax, Experian, and TransUnion). While reviewing your credit reports, if you feel there is inaccurate information listed, you should contact the lender directly.

What Kinds of Credit Affect My Credit Score?

While many factors can impact your credit score (which we will discuss in this Money Chat), the two kinds of credit that have the biggest effect on credit scores are installment credit and revolving credit.

Installment credit is a line of credit for which you make equal payments over an agreed amount of time until the loan is paid in full. If installment loan payments are made on time and loans are paid in full, they can be a big help to your credit score. Examples of installment loans include (but are not limited to):

  • Auto Loans
  • Mortgage Loans
  • Personal Loans
  • Student Loans

Revolving credit is a lump sum of money that you can borrow against over and over while making monthly payments toward the balance. The payment amount can fluctuate from month to month, going up and down according to your balance and interest rate. Revolving credit accounts generally require a minimum payment to be made each month. Revolving credit can help your credit score, but it must be used responsibly to gain benefits. Examples of revolving credit include (but are not limited to):

  • Credit cards
  • Retail cards
  • Personal lines of credit
  • Home equity lines of credit

To learn more about the difference between installment credit and revolving credit, visit the Receivables Info Resources page.

5 Ways That Debt Can Affect Credit Your Score

Your outstanding debt can impact your credit score which, in turn, impacts your ability to get approved for new credit. Making more informed and financially healthy decisions can lead to a higher credit score which can have a long-term positive impact on your financial well-being. Credit scores are calculated using scoring algorithms which means that many pieces of information are used to calculate a credit score. However, the five factors listed below are generally the most important elements in determining your credit score. Consider these major factors when reviewing your credit report and applying for new credit, closing existing credit accounts, and creating a budget.

Credit Score Factor #1: Payment History

Payment history is a record of payment activity to your creditors over the length of various types of accounts. Making up approximately 35-40% of your credit score, payment history is the biggest factor in determining your credit score number. Payment history shows whether or not you have made payments on time and paid them in full. It is important for you to remember that past due payment information stays on your credit report for up to seven years and the more recently you’ve had a late payment or missed a payment, the greater the impact it will have on your credit score.

Credit Score Factor #2: Credit Utilization Rate

Your credit utilization rate is calculated by taking the amount of available credit that you are using (such as a credit card or loan balance) and dividing it by the total amount of available credit that you have (the credit card or loan’s limit). A credit utilization rate over 30% can hurt your credit score. For example, if you have a balance of $5,000 on a credit card that has a $10,000 limit, to find your credit utilization rate, you take the balance of $5,000 and divide it by the credit limit of $10,000 (5,000 ÷ 10,000=0.5). To turn the resulting number/quotient into a percent and find your credit utilization score, multiply the quotient by 100 (0.5 x 100=50%). Depending on the scoring model, credit utilization accounts for approximately 20% of your overall credit score. 

Credit Score Factor #3: Credit History Length

Generally, the longer you have had credit, the greater your credit score will be. Length of credit history comprises approximately 21% of your overall credit score and a credit history length of 7 years or greater will have a positive impact on your credit score. FICO® also uses an AAoA, or Average Age of Accounts, to determine your length of credit history. Your AAoA is determined by dividing the age of your oldest and newest accounts (both open and closed) by the total number of accounts. For example, if you have revolving and installment accounts that have been open for 1 year, 2 years, 4 years, 4 years, 7 years, and 9 years, your credit history length is calculated by adding the age of all of the accounts and dividing by the total number of accounts. In the example above, 1 + 2 + 4 + 4 + 7 + 9 = 27 ÷ 6 = an average of 4.5 years. Scoring models will usually drop any number after the decimal point which leaves you with an average credit history length of 4 years.

Credit Score Factor #4: Credit Mix

Credit mix is the different types of credit that you have or the diversity within your personal credit portfolio. It accounts for approximately 10% of your overall credit score and is typically the most overlooked factor by consumers. Your credit portfolio is the combination of different types of revolving and installment credit. This can include credit cards, car loans, mortgages, personal loans, and more. Properly maintaining a mix of credit with excellent payment history and low utilization rates can be an influential factor in boosting your credit score, but having a less diverse credit mix (or even just one type of credit in your portfolio) doesn’t necessarily drive down your credit score.

Credit Score Factor #5: New Credit

Depending on the scoring model used, new credit makes up approximately 5-10% of your credit score. If managed wisely, a new line of credit can be helpful to your score in the long run, but, rapidly opening many accounts within a short time span can hurt your credit. Credit scoring takes into account the age of your most recent account or the amount of time since you last opened a new line of credit. Rapidly opening new accounts, one after the other, can be a sign of financial instability and indicate you as a greater risk for lenders. Keep in mind that every account you open changes the length of your credit history by adding another account to the total, diluting the average and impacting your credit score in more than one way.

What Hurts My Credit?

Many things can hurt your credit, but missing payments and/or defaulting on accounts are the biggest factors that can drive down your credit score. When trying to repair or build credit, do your best to avoid overspending. Set up your budget wisely to prevent applying for too many lines of credit in a short period of time and refrain from using up too much of your available credit. In addition to missing payments, both of these factors can quickly hurt your overall score.

How Do I Improve My Credit?

Strategically paying down your debt incrementally improves your overall financial health and your credit score. Resolve any outstanding payments, commit to making payments on time, and reduce your credit utilization rate by paying down your debt. Check your credit reports to get a clearer picture of the status of each account and make a plan. When reviewing your reports and making financial decisions, take into consideration your standing with each lender, each account’s payment status, and your debt utilization ratios. If you suspect inaccurate information on your credit report, contact the lender as soon as possible.

How Do I Build Credit If I Don’t Have Any?

Some people may not have any credit history, and thus no credit score, at all. Or, there may not be enough information in your credit history for the scoring algorithm to assign you a three-digit credit score. Two ways to get started building credit are to get approved for a secured credit card or become an authorized user on a family member’s credit card. Just remember to use credit wisely. Avoid using all of your available credit and make payments on time.

Life Happens

Life is unpredictable and each person has a unique financial journey. When unforeseen circumstances arise, having a healthy savings account can help you survive a financial storm. But don’t despair if you find yourself in a bad situation without the means to meet your financial obligations and your credit score falls; your credit score is repairable. With good decisions and small steps, your credit score will begin to go up, and with continued perseverance and financial commitment, you can get back on the path to financial wellness and a better credit score.

Additional Resources

If you want to develop a deeper understanding of consumer credit, please visit the Receivables Info Resources to access the Understanding Consumer Credit Money Chat. To learn more about credit, we recommend that you visit the website of the three major credit bureaus to gain more detailed and specific information including these important topics:

For more information about financial literacy and to access additional consumer financial resources, please visit the Receivables Info Resources Page.

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The information contained in this article is meant to serve as general guidance for consumers and not meant to serve as comprehensive financial advice. For questions about your individual circumstance, finances, or accounts, please contact your creditor(s) and/or financial advisor directly.

Thank you to our Sponsor

This article was sponsored by Northwood Asset Management Group. Located in Williamsville, NY, Northwood Asset Management Group (NAMG) is a nationally-licensed, professional third-party debt collection company representing creditors in the resolution of account balances. Northwood Asset Management is committed to delivering services with professionalism, respect, and complete compliance. NAMG actively gives back to the communities they serve while working hard to find mutual agreements between creditors and account holders that enable both parties to move forward. The company was founded in 2012.

Published On: March 1st, 2021|Categories: Money Chat|Tags: , , , |

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