debt credit

Pay Down Your Debt to Improve Your Credit


by

29 May,2012

When you have poor credit, it becomes important to fix the situation. Poor credit results in higher interest rates, as well as other costs. Additionally, your credit situation can have an impact on your insurance rates, approval for services, and even your ability to gain employment.

While there are various ways to improve your credit, and boost your score, one way you can help your situation is to pay down your debt. Reducing what you owe can have a positive effect on your credit score, as well as help you save money in interest charges.

Credit Utilization

The amount of available credit that you use has a big impact on your credit score. In fact, your credit utilization is the second most important factor in your credit score, behind your payment history. If you want to help your credit score, one way to do it is to reduce your debt levels.

Start with your credit cards, since a credit card has a profound impact on your credit score. It’s easy to track changes in credit utilization with a credit card. As you pay down your debt, your report will show that you have credit available — and that you aren’t using very much of it. When you use less of your available credit, that’s considered a positive thing for your credit report and credit score.

Pay down some of your debt so that you aren’t using up so much of what is available.

Less of a Credit Risk

Tackle your debt, and you can show that you have more room for safety in your debt situation. Someone with a large amount of debt is considered to be in a financially vulnerable situation. If you have a lot of debt, it is a signal that even a small setback could cause problems and render you unable to meet your obligations.

Your credit score is derived from an algorithm that analyzes the risk that you will default on your credit obligations. If you have a high credit score, you are considered responsible, and more likely to repay your obligations. Because you are seen as less of a risk, you are eligible for better loan terms, and can save a great deal of money. By contrast, if you have a low credit score, you are seen as a higher risk of default. If you are seen as too risky, you might not even be able to qualify for a loan. If you are just risky enough to take a chance on, you will be charged a higher interest rate to help offset the risk the lender is taking on you.

Paying down your debt can help you appear as less of a credit risk. Your lower debt indicates that you are more financially stable, and that you are able to better absorb financial setbacks. Paying down your debt is a signal that you are better prepared to take on other types of credit, and the fact that you are less of a risk entitles you to a lower interest — and the thousands of dollars in potential savings that can come with that lower interest rate.