Any consumers who have used credit have a credit score. Various companies calculate credit scores, and each uses its own formula. While there is no precise way to calculate your score without knowing the exact formulas used, you can get an approximation of how debt influences your score by reviewing the factors used to calculate credit scores.
Credit Scores and Debt
The purpose of a credit score is to provide current and potential creditors a means to gauge the risk you represent. Lower scores mean you are more likely not to repay a debt, while higher scores mean you are more likely to repay, making you a less risky investment. How much debt you carry plays an important role in determining your credit score.
Credit Utilization
With credit cards, the number of times you use the card is not as important as the balance you carry. Every credit card has a credit limit, and the amount of the balance you carry relative to that limit is known as your credit utilization ratio. A low credit utilization ratio improves your credit score. According to Kiplinger, borrowers with a utilization ratio of 25 percent or lower are viewed more favorably than those with higher ratios and generally have higher credit scores as a result.
Fewer Cards, Lower Score
Paying off your credit card debt completely or keeping the credit-utilization ratio low generally increases your credit score. However, canceling a credit card often has a negative effect on your score, although that may seem counterintuitive. When you cancel a credit card account, you remove that card from your list of open credit lines, and it no longer gets included in the average length of time you've had each credit line. This factor makes up 15 percent of your score, and decreasing the average history length can decrease your score. Also, closing an account lowers your available credit, which raises your credit utilization ratio.
More Debt Types, Higher Score
About 10 percent of your credit score comes from the kinds of debt you use. In general, having a variety of credit types, such as a car loan, mortgage and credit card accounts, is preferable to having only one or two kinds of accounts. If, for example, you only have credit cards (which are revolving debts), obtaining a car loan (which is an installment loan) can improve your credit score. Even though you owe more, your creditors can better evaluate how you handle different types of credit, and thus give you a better score.
Tags: your credit, credit score, credit card, your credit score, your score, utilization ratio
