Debt isn’t inherently a bad thing—in fact, having a little bit of debt can actually help your financial situation in the future.
Most people don’t have the capital to pay for things like a home or a car in a single transaction, so you’ll likely need to take out a loan to help pay for the items you want. If you already have a healthy debt history, lenders may be more inclined to provide you with a loan; however, if you have struggled with debt in the past, it might be harder to find loans.
Lenders determine if you’re someone they’d like to work with by checking your credit score; a ranking system that illustrates how well you’ve managed debt in the past.
But how does this system work, and is there such a thing as “good” debt and “bad” debt? Let’s look at how debt can affect your credit score and what type of debt can have the most impact.
If you’re currency struggling with your debt situation, we’re here to help. Contact the A.C. Waring & Associates team and discover how you can turn your financial situation around today.
What Is a “Credit Score?”
So before we look at how debt can affect your credit score, it’s important to understand what a credit score is in the first place.
A credit score is a 3-digit figure, ranging between 300 and 850, that attempts to numerically rank a person’s “creditworthiness.” For all intents and purposes, it is a quick and efficient way for lenders to determine if a person can manage their debt.
Credit scores are calculated by taking into account a variety of factors, like your income, the types of debt you have, how much debt you have, and how well you’re managing your current debt load. The more problems you have with your debt history (like missed payments, too many credit accounts, or high balances), the lower your numerical score is.
However, just because your score is low now doesn’t mean you can’t improve it over time. With effective debt management strategies, you can slowly increase your score, making you look more desirable to possible lenders in the future.
Credit score ranges may differ between the model being used, but most follow a similar structure to this system:
- Poor: 300-579
- Fair: 580-669
- Good: 670-739
- Very Good: 740-799
- Excellent: 800-850
Good vs. Bad Debt
Now that we know what a credit score is, let’s look at what “good” and “bad” debt are and how they differ.
Now, it may be easy to think that debt is a bad thing to have, but the opposite is true. Certain types of debt can be very good for your financial well-being, provided that you can manage it properly.
For example, a good type of debt is something that you can pay off over a long time, with a relatively low interest rate and minimum payment. A bad type of debt can be a lot more volatile, with high interest rates and monthly payments. Take a look at the following types of debt for an idea of what is typically considered “good” and “bad.”
It’s important to note that if you can keep up with regular payments and keep debts from getting out of control, you can use any debt to improve your credit score. These examples are just what are typically considered “good” and “bad” based on how easy they usually are to manage.
- Car loans
- Student loans
- High interest credit cards
- Payday loans
- Unsecured personal loans
It is important to note, however, that not all debt is readily in the credit bureau. Apparently. In Canada, there are only about 300 recording members. These include banks, auto finance companies and collection agencies. Apparently they do not include CRA, utilities, long term mortgages and landlords. So not all loans are included in any given computation of your credit score.
How Does Debt Affect Your Credit Score?
Now that we’ve looked at which debts can affect your credit score, let’s look at how these debts can affect your credit score.
For the most part, as long as you manage your debts for long periods, you should have a pretty healthy credit score. That being said, here are some common ways you can affect your credit score:
- On-time payments: On-time payments are the most important thing to remember when managing your debt. If you miss a payment, it can seriously impact your credit score. If you miss a payment for over 30 days, your lender may report you to the credit bureau. Doing this will leave a note on your credit report that will last up to 6 years.
- Types of debt: Having a variety of debts can be a great way to increase your credit score, but it can also lower your score if you have a variety of “bad” debts. For example, having several types of credit cards can lower your credit score, but having a car payment, mortgage, and credit card may increase your score, provided that you’re making on-time payments.
- Credit history: Long-term credit history is a great way to increase your credit score, showing lenders that you can handle your credit obligations for long periods. If you have several types of credit that are all relatively new, this might lower your score.
- Balance vs. credit limit: High credit balances could indicate to lenders that you have too much debt and might be unable to handle more if they decide to lend you money.
Get Help Improving Your Credit Score Today
Improving your credit score is all about understanding your debt types and managing them properly. With a little planning, you can increase your credit score over time and make it easier to take out loans when needed.
If you’re struggling with debt management, find out how we can help and call 780-424-9944 and talk to the A.C. Waring & Associates team today.