Your debt plays an important role in determining how your credit score is calculated. Aside from your payment history, your outstanding debt has the largest effect on your credit score, accounting for 30%. It’s important to learn how to manage your debt in a way that benefits your credit score.
Understanding Credit Utilization
Credit utilization comes into play with revolving debt such as credit cards. Credit utilization is the ratio of credit card balances to credit card limits. As an example, if your credit card balance is at $500 on a credit card with a $1,000 limit, then your credit utilization is 50%.
There are two ways that credit utilization can affect your credit score. First, if any individual credit card has a balance of more than 20% of the credit limit, your credit score can be negatively affected.
Next, your score can also be affected by your total credit utilization. Your total credit utilization means all of your individual credit card balances added up. If you keep your balances low, you shouldn’t have to worry about this.
Maintaining a Mix of Debt Types
The type of debt you have accounts for 10% of your credit score. Ideally, you should have a mix of credit cards, retail cards, installment loans, and mortgages. While it’s not required to have one of each of these debt types, maintaining a mix of different debt types will have a positive effect on your credit score.
While a mix of debt types is ideal, it’s not recommended that you open accounts merely for the purpose of adding to your mix of accounts. Only open accounts that you intend to use.
Maximizing Your Credit Score
Now that we’ve covered the different aspects of debt and how they can affect your score, let’s outline the best ways to maximize your credit score.
- Keep your credit card balances as low as possible. Preferably your credit utilization should stay under 20%.
- You can decrease your credit utilization by increasing your credit card limits. You can do this by calling the credit card companies and requesting that they increase your limit. Keep in mind that by increasing your credit card limits, you’re taking on the responsibility of maintaining a low balance.
- Make your payments on time.
- Remove negative entries from your credit report such as collections and charge offs.
- Maintain a mix of debt accounts such as credit cards, retail cards, installment loans, and mortgages.
There is a direct correlation between your debt and credit score. When debt is responsibly managed by making on time payments, avoiding high balances, and removing negative entries, your credit score will reflect this positive behavior.