If you don’t manage your debt effectively, your credit score can decrease. This can be due to a number of reasons, including late payments, high total balances, high credit utilization or too many applications for new credit.
On the flip side, strategically using a credit card and taking on manageable installment debt can improve your credit. That means it’s important to strike a balance between using debt to your advantage while preventing it from getting out of hand.
How does debt affect your credit score?
When you have a lot of outstanding debt relative to your credit limit or a history of late payments, that signals to creditors and their credit scoring models that you’ve had difficulty managing debt in the past and that you may have trouble paying back debt in the future.
As a result, you may receive a fair or poor credit score, which will make it harder to obtain new credit and likely result in higher annual percentage rates (APRs) for any credit you do get. However, there is some nuance to how debt affects your credit score. Merely using a credit card or taking out a loan isn’t a red flag. In fact, having a healthy credit mix—a range of revolving credit like credit cards and installment credit like loans—can help your credit score. Adding positive payment history from credit card or loan accounts to your credit report can also improve your credit.
It’s important to only take out loans you know you can pay back on time each month. Also, keep your credit utilization rate—or the percentage of revolving credit limit you’re using on each credit card, and overall—as low as possible.
How to manage debt
Taking on debt doesn’t have to lead to a lower credit score. Using a credit card judiciously and making regular payments toward installment loans can strengthen credit. Here’s how to make sure debt works in your favor.
Set up autopay
For all credit card or loan accounts, pay your bills on time, every time. On your lender’s or issuer’s website, set up automatic payments from a bank account each month. Ideally, for credit cards, set up autopay so that you pay your whole outstanding balance. Throughout the month, make sure you have enough cash in your connected bank account to prevent an overdraft.
Pay off credit cards each month
To keep credit card debt under control, aim to use less than 30% of your credit limit at all times, but lower is better. To ensure you don’t carry debt from month to month, incurring interest charges and making your balances grow, pay off your outstanding balance every billing cycle.
How to improve your credit score
To further improve your credit, consider taking the following steps:
Avoid closing your oldest credit card. Even if you no longer have use for your oldest card, its age can benefit your credit score, especially if you don’t have many other credit cards or loan accounts. Rather than closing a credit card, consider using the card for a small recurring purchase.
Limit new credit applications to what you really need. Taking on more credit cards or loans than you can handle will put you at risk of missed or late payments. Plus, too many applications for new credit can negatively impact your credit score.
For more information on improving credit, see the following articles: