Does Your Debt Lower Your Credit Score? 

The “D” word comes with a lot of hang-ups. While your latest personal loan might help you fix a leaking roof, the debt you gain may become a burden for your budget. Each outstanding personal loan and line of credit demands a bit of your paycheck, leaving behind a smaller pile of cash to spend on other things.

With each payment toward your loan, you dismantle your debt dollar by dollar. But while you have an outstanding balance, your debt may be impacting your credit score — which can influence your borrowing experiences in the future. 

Let’s unpack that. Below, find out how your debt affects your credit score. You might find the motivation to help you pay off debt once you know the reality of your personal loans. 

Does the Exact Dollar Amount of Your Debt Matter?

Your account balances matter beyond what they mean for your budget. They can also factor into your credit score depending on your account. 

In most scenarios, the balance matters most when it comes to your revolving accounts. Those are the lines of credit and credit cards that you have in your financial toolkit. If your lender shares your account information with one of the credit bureaus, your balance factors into your credit utilization ratio.

The utilization ratio shows how much of this account you use in percentage form. (To find your ratio, punch your outstanding balance into a calculator and divide it by your account’s limit). It’s the second biggest factor considered by the bureaus, worth 30% of your score. 

If your balance is high, your utilization ratio will be high, too. Generally speaking, you should never let your ratio go above 30%. Anything above this benchmark may reduce your score — the higher you go, the worse it will be. That’s why most financial advisors recommend you aim for a single-digit ratio.

Does Your Personal Loan Balance Matter?

Personal loans that are not revolving — think term loans that close when you pay off what you owe — do not influence your utilization ratio. They affect your debt-to-income (DTI) ratio, which shows how much of your income goes to debt payments. 

Your DTI is not one of the five official factors of your score, which means your personal loan balances won’t directly affect your score. 

However, it can still impact your ability to borrow in the future. Some lenders check your DTI before they extend a personal loan. If they deem your DTI too high, they may reduce what they offer or deny you outright. 

Focus on Paying Down Your Balances

Your utilization ratio is the second most important factor of your score. The first? Your payment history. Consistently paying bills on time is the single greatest thing you can do for your financial health, as this avoids late fines and keeps your accounts in good standing.

If you have this habit down pat, sit down with your budget to determine how to pay down your revolving accounts faster. The sooner you can reduce your balance, the faster your utilization ratio will go down. Eventually, this good behavior will pay off and reduce your score. 

You may also want to ask your credit company if they will increase your account’s limit. This limit increase will amplify the work you do to reduce your balance. 

Together, these money management tips may help you reduce your debt and increase your score.