I Was Deeply in Debt and Still Had a Good Credit Score. Here's Why

I've made a lot of money mistakes, but this wasn't one of them.

If you don't work in personal finance, it's likely you don't think about credit scores too terribly often. Your credit score can have a major impact on your financial life, however. With a good one, you'll be eligible for lower interest rates on mortgage loans, personal loans, and auto loans. You may save money on insurance. You'll also be able to take advantage of credit cards with the best rewards, like a nice rate of cash back or points. The converse of this is that if your credit score is on the low side, you'll pay more in interest -- and have a harder time getting approved for loans and credit cards.

I spent 2022 climbing out a massive pit of debt thanks to a career change I wish I had pursued sooner and taking on freelance work. Despite being in debt, my credit score at the time was still over 700. What's up with that?

How does a credit score work?

There's a lot to learn about credit scores and how they're calculated. The FICO^® Score is the industry standard and is used in a majority of lending decisions. It's made up of five different factors, in varying percentages:

1. Payment history: 35%
2. Amounts owed: 30%
3. Length of credit history: 15%
4. New credit: 10%
5. Credit mix: 10%

Each of these has an impact on your score, but as you can see, some of them matter more than others. The two biggest percentages, payment history and amounts owed, are especially important to pay attention to if you're trying to rebuild your credit.

In my case, my credit utilization ratio was very high (remember, amounts owed relative to available credit makes up 30% of your credit score). "Credit utilization ratio" is the term for the percentage of credit extended to you in the form of revolving credit (such as credit cards) that you're actually using. Ideally, lenders like to see a credit utilization ratio of under 30%. This means that if you have a credit card with a $10,000 limit, you're keeping your average balance below $3,000. And it's always a better move to not carry a balance from month to month at all, if you can avoid it, because credit card interest is not cheap.

On-time payments saved my credit score

At the time I was struggling with debt, I hadn't made a late payment on any of my accounts in a very long time. My experience with short-selling my house had resulted in some damage to my credit score (which wasn't all that great at the time anyway), and I had resolved to improve it. The easiest way for me to do that at the time was to get very good about making on-time payments. I was sometimes making only the minimum payments on different accounts, but I never incurred any late fees or pointed reminders from my creditors that I owed them money.

I started rolling my debt snowball in 2022, and by the time I was out of debt, I had watched my credit score climb from the low 700s (in the "good" range for FICO^®) to over 800 ("exceptional"). This gain of more than 100 points was likely due to my credit utilization ratio shrinking to a very low percentage.

Keep making those on-time payments

If you're working your way out of debt or looking at a less-than-great credit score and feeling overwhelmed, remember those percentages from above. Even if you have to carry debt for a while, getting into a routine of making every payment on time will have a positive impact on your score.