Many Americans have dealt with considerable debt problems in the last few years, often brought on by financial strain that they couldn't avoid, and that in turn has required that many borrowers do all in their power to rebuild credit that was damaged as a consequence.
However, there are still many debt pitfalls into which consumers can fall, and it is therefore important that those who have taken the time to rebuild good credit scores to keep in mind what they might have done in the past that led to the difficulties they've had to overcome. Because the amount of debt being carried by a consumer will have a profound effect on his or her credit score, it's particularly important to understand the relationship between balance size and credit standing to better avoid diminishing the latter as the former grows.
How debt affects borrowers' scores
While the biggest factor used in determining a person's credit score is whether they have missed any payments in the past several months, the second-largest by far is the amount of debt they carry versus the amount that's allowed by their various lenders. This concept is known as a person's "credit utilization ratio," which makes up 30 percent of a rating, but contrary to popular belief, the more being carried, the worse off that borrower's rating will be.
In general, lenders like to see consumers carrying debt loads of 30 percent of their total credit limits or less, and the closer to that level they are, the better they will likely be. For instance, suppose a person has available credit limits of $10,000 spread across three credit cards, but is carrying $5,000 in debt. That means they have a credit utilization ratio of 50 percent, and are significantly diminishing their score as a consequence. Taking the time to work that balance down to $3,000 or less will help them to put their standing back to where it should be, and also improve their financial flexibility.
While that 30 percent is all that's required to max out this portion of one's score, those looking to avoid debt problems should work to reduce it all the way to zero if possible. Making larger payments in the short-term may sound like a difficult project to undertake, especially for those whose budgets are already stretched thin, but the resultant benefits down the road will likely be considerable. For example, the lower borrowers' various outstanding balances are, the smaller their required minimum payments will be every month. And, thanks to relatively new consumer protection laws, lenders are required to apply any amount paid above the minimum listed on a bill directly into the balance's principal, meaning that their obligations will be reduced more quickly going forward and put them in a position to get out from under those debt loads sooner.
What benefits reducing debt can carry
There are many reasons that a borrower may want to take the time to slash his or her debt, including the ability to avoid costly bills every month, but an improved credit score is likely one of the most beneficial they will come across. Having a higher score means that they may be able to tap many benefits they otherwise might not have had access to.
For instance, a higher credit score grants consumers access to accounts reserved for only those with high ratings, and these can carry a number of perks. Many lenders reserve the best deals on rewards credit cards for those with top-notch standings. But beyond that, even terms on accounts with fewer frills will be improved considerably; those with the best scores can expect to pay very little in the way of interest rates, and significantly reduced or even no fees for maintaining the accounts. In general, having higher ratings will also make it easier for borrowers to obtain whatever lines of credit they may want.
That, in turn, makes borrowing — which can sometimes be necessary — far more affordable, and therefore allows consumers to avoid racking up debt as quickly as they might have in the past. However, borrowers who have worked diligently to improve their scores so that they can be eligible for this type of more affordable account should also keep in mind that it's in their best interest to maintain low balances by charging less every month, and paying more into their debts.
There are other benefits as well, such as the potential to have greater eligibility for jobs, utilities and other services, and even renting apartments. That's because a large amount of non-financial organizations now use a person's credit standing to determine their eligibility.
Consumers looking to improve credit may also want to check copies of their credit reports for any unfair markings that can have adverse effects on their scores. If any are discovered, working with a credit repair law firm may help correct them.