If you have a loan, a credit card or a mortgage, you have a credit score. Whether you have a high or low credit score depends on how well you managed your finances. Your debt plays a part in your credit score. People have many reasons for going into debt. Whatever the reason, carrying large debts hurts your credit score.
How Credit Scores Work
When factoring your credit score, the Fair Isaac Corp. considers how much credit you have, the types of credit you have, how many times you applied for new credit in the recent past, how long you have been managing credit and how much debt you own. The amount of debt you have factors heavily into your credit score. American Student Assistance reports that your total debt makes up 30 percent of your credit score. Carrying a high balance on your credit cards also affects how a lender sees you. Prospective lenders see a maxed-out or high-balance credit card as an inability to manage credit.
Why Debt Happens
Many people go into debt after a sudden financial crisis in their lives. For example, if you lost your job, you may have to rely on credit cards to cover daily expenses. Without steady income, you cannot afford to pay the entire balance on your credit cards each month, and the debt piles up. Others live beyond their means. If you spend more than you make, you will rack up debt. Some people accumulate debt from a lack of proper budgeting. If you do not know how much you can afford to spend, you can easily charge more than you can afford to repay.
The Effect of Debt
Carrying large debts will bring down your credit score. If you let those debts go unpaid, the lender will report your account as a charge off and turn it over for collections. Charge offs and collection accounts cause black marks on your credit report. You will have a harder time getting out of debt the longer you allow the debt to build up. Lenders charge you interest on any unpaid balance on your credit card. The interest compounds every month you do not pay off the balance.
Resolving Debt
Creating and following a strict personal budget will help you get out of debt. To create a budget, calculate your total monthly bills, including the minimum payment due on any credit cards. Subtract your bill amounts from your take-home income. You can use any excess income to pay down your debts. You can start by paying down the smallest debt first, or by paying down the debt with the highest interest rate. Paying debts by size will help you get through all your debts faster. Paying debts according to interest rates will save you money over time.
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