Imagine you’re playing cricket, and you’re chasing a target of 250 runs in 50 overs. If you keep losing wickets while trying to score quickly, it becomes harder to win. Similarly, in life, your “credit score” is like your performance score in cricket, and managing debt is like balancing between runs and wickets. Though you can manage multiple debts through debt consolidation and make your life easier.
What Is a Credit Score?
A credit score is a three-digit number that ranges from 300 to 900 depending on how efficiently you repay the borrowed money. The higher the price, the easier it is to borrow money from banks and lenders alike.
Key Components of Credit Score
To know how debt impacts your credit score, let’s break down its components:
| Component | Weightage | What It Means |
| Payment History | 35% | If you pay your bills on time, it boosts your score. |
| Amounts Owed | 30% | This includes how much debt you owe and how much of your credit limit you’re using. |
| Length of Credit History | 15% | How long you’ve been borrowing matters. |
| Credit Mix | 10% | Having a variety of loans, like home loans and credit cards. |
| New Credit | 10% | Applying for too many new loans in a short time can lower your score. |
The Relationship Between Debt and Credit Score
1. Impact of Outstanding Debt
Let’s say Ravi earns ₹50,000 a month and has a personal loan of ₹5,00,000. His monthly EMI is ₹15,000, which is manageable. But if he takes another loan and his EMI rises to ₹30,000, lenders might see him as a risk, lowering his credit score. Keep your debt-to-income ratio below 40%.
2. Credit Utilization Ratio
Imagine you have a credit card with a limit of ₹1,00,000 and you spend ₹80,000 every month. This means you’re using 80% of your limit, which can hurt your credit score. Monika Halan, the author of Let’s Talk Money, recommends using less than 30% of your credit limit in her recent podcast. (₹30,000 in this case).
3. Late Payments
Ananya, a school teacher, missed her loan EMI of ₹10,000 last month. As a result, her credit score dropped by 50 points, even though she paid it the next month. Lenders consider timely payments very important. Even one late payment can have a big impact. Use reminders or auto-pay options to avoid this.
Good Debt vs. Bad Debt
- Good Debt: Loans you can use for economic development such as home and education loans. For example, Neha took an education loan of ₹5,00,000 and repaid it over 5 years. Her score improved because she made timely payments.
- Bad Debt: High-interest credit-card bills on non-essential expenses. For instance, Raj spent ₹50,000 on a trip using his credit card and paid only the minimum amount due each month.
Facts:
- According to a report by the Consumer Financial Protection Bureau (CFPB), consumers with lower credit utilization rates tend to have significantly higher credit scores. For instance, those maintaining their credit utilization below 30% are more likely to achieve credit scores upto 750.
- The average score decline for people with one late payment in 12 months is 90-110 points.
How to Improve Your Credit Score
You can Improve your credit score by focusing on these aspects:
- Pay on Time: Like scoring singles in cricket, small, consistent payments build a strong credit history.
- Lower Your Debt: Pay off high-interest loans first.
- Limit Credit Card Usage: keeping within 30% of your limit.
- Check Your Credit Report: Look for errors and report them to fix your score.
- Diversify Credit: Manage different types of loans responsibly.
