A person’s credit score is a financial metric that can have long-lasting impacts on their ability to borrow money or make large purchases that will require loans in the future. Every form of debt has its own impact on a person’s credit score and credit history. Learning about this relationship can help anybody make a more educated financial decision on whether or not they should be taking out debt.
What is Credit?
Credit is a broad term that can be difficult to understand due to its different parts. However, put simply, credit refers to a person’s ability to borrow money or access goods and services with a mutual understanding that you will pay in full at a later time. A lender will grant you money to make a purchase only if they have confidence that you can be trusted to repay the funds, which is partially determined by your credit score and credit history.
Your credit score is simply a three-digit number that is designed to represent your specific credit risk, determining the creditworthiness of an individual. A person’s history with debt has a direct impact on this score.
What is Debt?
Debt is any form of money that is borrowed from one party and provided to another. Debt arrangements allow a person permission to borrow money from another group under the condition that they will repay that money, along with any borrowing fees or interest, at a later, predetermined date.
Debt has four main categories: secured, unsecured, revolving, and mortgaged. Secured debt requires collateral, or something of the borrower’s that is pledged as security when taking out debt. Unsecured debt is a sum of money borrower with no collateral pledged. Revolving debt is when a borrower has access to funds up to a certain amount, which they can borrow from and repay at their leisure. Finally, mortgaged debt is debt secured by a lien on real property.
How is a Credit Score Calculated?
When looking at situations such as does a title loan affect your credit or how does non-repayment of a personal loan impact credit history, there are a number of factors that determine the scope of the answer. These factors all play into how a credit score is calculated. There are five main pieces to a credit score that are measured and weighed on a, typically, monthly basis:
- Payment history accounts for roughly 35% of your score.
- Current outstanding balances accounts for roughly 30% of your score.
- Length of credit history accounts for roughly 15% of your score.
- Types of credit accounts for roughly 10% of your score.
- Recent credit activity accounts for roughly the final 10%.
As you can see, the largest factors are your history with debt payments and how much you currently have borrowed compared to your total limit (referred to as credit utilization). Non-payment of past debt can have a major negative impact on your calculated score.
Factors Which Influence a Credit Score
It’s one thing to see the different aspects used to calculate a credit score, but it’s another to look at the specific positive and negative factors that change those aspects. Here are some of the most notable:
- Complete repayment of a debt obligation on-time and in-full
- Borrowing under 30% of your total credit line
- Long and positive history of credit
- A mix of different types of credit accounts, such as revolving, installment, and open
- Consistently missing debt payments
- Applying for too many loans at a single time
- Account balances that are too close to their limit
- Too short of a credit history
- The existence of collection accounts
As evident by the above, there are a number of factors that can influence your credit score. Overall, maintaining a positive repayment history along with a healthy relationship with debt is the best way to improve your credit score.
General Tips for Improving Your Credit
Generally speaking, there are a few key tips you can follow to start improving your credit score:
- Don’t miss any debt payments.
- Build your credit file up over time.
- Catch up on any past due accounts.
- Pay down any revolving balances you may have.
The relationship between debt and credit is complex, which makes improving that relationship all the more important before trying to take out funds for a large purchase.
Elevate your financial position today
The simple decision to take on debt when you aren’t able to pay it back can have major implications for your financial situation and credit score. These implications can affect your life for years to come, which is why developing a healthy relationship with debt is so important. Never borrow funds you are unable to repay in full and within the required repayment period.