How Your Debt Affects Your Credit Score

How Your Debt Affects Your Credit Score

Written by Caitlin Wood
Last Updated June 2, 2021

Many consumers are not aware of how their debt affects their credit score and may end up sabotaging efforts to improve overall rank. As plastic beckons with alluring promotions it becomes increasingly important to know how banks and other institutions measure risk and how to make your payments to keep them manageable and to maintain positive credit ratings. With companies requiring deposits based on your score it is important to keep it as high as possible so read this article and learn how your debt affects your credit score and methods to improve your ratings.

5 Ways Your Debt Affects Your Credit Score

There are many common misconceptions regarding bank and credit card debt and its impact on your credit score. As credit score becomes increasingly important in many aspects of daily life, from applying for insurance to renting a home or apartment, it is crucial to understand how it works. Learning how your payments, debt consolidation and overall debt impact the numbers can help you make wise decisions.

1. Credit card companies, as well as banks, typically extend more cards and higher credit limits to customers who make regular payments, including those who just make the minimum monthly payment. The high interest rates charged by most credit card companies tends to be considerably higher than a bank is able to charge for a traditional loan. Although they are carrying a balance, the interest continues to accrue, and consumers eventually have even higher balances due to compounding interest. The monthly minimum may never make a dent in the principal, and you will eventually pay for the purchase many times over by making only a small regular payment. Banks will look at this and consider whether the principal is being paid down or whether you are only able to meet the minimum payments when you apply for a loan.

2. The length of time you have had a credit card, your payment history, and its interest rate, and how many cards you have altogether, are all factors that are considered by banks when you apply for a loan. Banks prefer to see a debt to credit ratio of less than 30%, and definitely less than 50%. But they also register danger signals when they see a lot of new credit has been applied for or that you can potentially run up a lot of debt on numerous credit cards. It is best to keep only 2 or 3 cards with low interest rates, a regular payment history, and low balances. For instance, having two cards at 30% total balance, rather than a single card at 60%, could help improve your credit score (so long as the total credit on both cards is greater than the credit available in the first single card holding a balance of 60%).

3. The type of debt you carry also affects your credit score. The payment history, total balance, and number of college loans, home loans, lines of credit, and car loans will also impact your credit score. Banks want to see regular payments with decreasing balances. They also want to know that consumers are financially savvy, perhaps choosing to use a line of credit or personal loan to pay off high interest credit cards. When choosing this avenue, always be sure to cancel the credit cards to decrease the risk of doubling overall debt.

4. A stable regular income assures a lender that you will be able to make the required payments in a timely fashion. Each lender will have a different current and proposed debt to income ratio they use to decide whether you are a good credit risk and whether you will be able to service the debt. This ratio may also affect your interest level, with higher risk borrowers forced to pay higher interest rates. Your overall credit score, payment history, and available credit, is also calculated into these rates.

5. There are good ways that your debt affects your credit score, including carrying a variety of different types of credit. If you currently have only credit card debt, the addition of a mortgage or home improvement loan can increase your overall score. One caveat to this, is to borrow only what is needed, its wiser to take time and perseverance to allow a natural rise in credit than to go deeper in debt to raise the score.

Although a high credit score makes it easier to borrow money, it can be easy to take on more debt than you can afford, which will eventually have a negative effect on your credit score. Use credit cards and loans wisely, as they are not adding to disposable income, but will have to be paid off using future earnings. Carefully look at the terms of the note or credit extension, checking interest rates to determine whether you will be able to afford payments that will lower the principal as well as keeping up with interest. How your debt affects your credit score will influence your ability to obtain insurance, rent a home, connect utilities and borrow money in the future.

Caitlin is a graduate of Dawson College and Concordia University and has been working in the personal finance industry for over eight years. She believes that education and knowledge are the two most important factors in the creation of healthy financial habits. She also believes that openly discussing money and credit, and the responsibilities that come with them can lead to better decisions and a greater sense of financial security. One of the main ways she’s built good financial habits is by budgeting and tracking her spending through the YNAB budgeting app. She also automates her savings so she never forgets to put aside a portion of her income into her TFSA. She believes investing and passive income is key to earning financial freedom. She also uses her Aeroplan TD credit card to collect Aeroplan points so that she can save money when she travels.

Click on the star to rate it!

How useful was this post?

Research & Compare

Canada's Loan Comparison Platform

Largest Lender Network In Canada

Save time and money with Loans Canada. Research and compare lenders before you apply. Share your experiences with Canada's top lenders.

Make Smarter Borrowing Decisions

Whether you have good credit or poor credit, building financial awareness is the best way to save. Find tips, guides and tools to make better financial decisions.

Save With Loans Canada

Special Offers

50 Free Trades Offer

50 Free Trades Offer
Ends August 31st, 2022

Almost $500 in commission-free trades. Code “50TRADESFREE”. Conditions apply.

View Offer
Borrow Today, Don’t Pay Till July

Borrow Today, Don’t Pay Till July
Limited Time

Borrow $500-$50,000 from Fairstone by May 31 and don’t pay until July.

View Offer
Build Credit With Refresh

Build Credit With Refresh
Popular

Build credit while spending money with the Refresh Financial VISA card.

View Offer
Build Credit For $7/Month

Build Credit For $7/Month
Popular

With KOHO’s prepaid card you can build a better credit score for just $7/month.

View Offer
Industry Spotlight

What's happening with Canada's credit industry?

addy ⎯ Making Real Estate Accessible To All Canadians

addy ⎯ Making Real Estate Accessible To All Canadians

Check out our interview with addy; a platform that allows Canadians to invest in different properties across Canada with as little as $1.

Read Post
Locator
Find The Best Rate
In Your Region
OR
Best Personal Loan Provider by Greedy Rates
Icon

Confidential & risk-free

All consultations and conversations with Loans Canada and its partners are confidential and risk-free. Speak with a trusted specialist today and see how we can help you achieve your financial goals faster. Loans Canada and its partners will never ask you for an upfront fee, deposit or insurance payments on a loan. Loans Canada is not a mortgage broker and does not arrange mortgage loans or any other type of financial service.

When you apply for a Loans Canada service, our website simply refers your request to qualified third party providers who can assist you with your search. Loans Canada may receive compensation from the offers shown on its website.

Only provide your information to trusted sources and be aware of online phishing scams and the risks associated with them, including identity theft and financial loss. Nothing on this website constitutes professional and/or financial advice.

Your data is protected and your connection is encrypted.

Loans Canada Services Are 100% Free. Disclaimer

Keep Track Of Your Credit Score

Subscribe with Credit Verify to monitor your credit rating and get your free credit score.