Here's How Paying Off Debt Helps Your Credit Score

by Maurie Backman | July 30, 2019

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The higher your credit score, the more likely you are to get approved for a loan or credit card. Higher scores also make you more likely to get lower interest rates.

There are several factors that go into calculating your credit score, and one important factor is the amount of credit you're using at once. If you're looking to boost your score, paying off some of the debt you've already managed to accrue is a good way to get there.

How credit utilization impacts your credit score

Credit utilization speaks to the extent to which you're using your existing line of credit. Aside from your payment history, it's the component of your credit score that carries the most weight.

A credit utilization ratio of 30% or less will help your credit score, while a higher percentage will hurt it. If you have $10,000 in available credit, your goal should be to never have more than $3,000 in debt outstanding, as it could bring down your score.

For this reason, paying down existing debt can improve your credit score. Let's imagine that you're carrying a $4,000 balance with $10,000 in total available credit. That leaves you with a credit utilization ratio of 40% -- not ideal. If you paid down $1,000 of that debt, you'd knock your balance down to $3,000 and your utilization would fall to 30%. That's much better.

Of course, paying down debt is easier said than done. A good way to get there is to write up a budget to see where your money is going from month to month. Then identify a few expenses to cut back on temporarily and use your savings to pay down your debt.

Getting a second job on top of your primary one could help you achieve a similar goal. By boosting your income, you'll have more money available to chip away at your debt until your credit utilization ratio is in more favorable territory. (Or, better yet, don't stop there -- keep knocking out that debt until it's gone.)

Keep in mind that if you're using a lot of your existing credit line, getting your limit raised will also help your score. Imagine you owe $4,000 in various credit cards. If you manage to get your total limit increased from $10,000 to $12,000, your utilization is back down at 30%. Right where you want it.

That move, however, still leaves you accruing costly interest on that $4,000, which is why paying down your existing debt makes more sense. Still, if you're in a pinch and need your score boosted quickly -- if you're looking to buy a home or take out a personal loan, for example -- raising your credit limit may be a reasonable solution, provided you commit to tackling your debt after the fact.

If your goal is to improve your credit score quickly, knocking out a chunk of existing debt can definitely help. Rethink your spending, at least temporarily, to free up cash, or get a side gig if that's what it takes to bring up your score -- especially if you'll be applying for a loan in the near future.

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