Credit Card Debt and Your Credit Score: Understanding the Impact
Life is full of competing financial interests. Say you recently put a somewhat pricey (but totally worth it!) gym membership on your credit card, and now you’re thinking about buying an electric vehicle. Could your commitment to leg day lead to heftier interest rates on your car payment?
If you’re curious about how credit card debt affects your credit score, it’s true that the higher your credit card debt climbs, the lower your credit score tends to drop. In fact, credit card debt stands out as one of the primary factors that can heavily influence your overall credit score.
Regardless of your income level, maxing out your credit cards sets off a warning signal for lenders. Whether you plan to get a new car, buy a home, or even just apply for another card, your existing credit card debt will directly affect the likelihood of approval and the interest rates offered.
So, with this interconnected relationship in mind, we’re sharing tips for managing credit card debt and improving credit scores. We’ll even show you how your local credit union can help with credit card best practices and credit repair.
What is Credit Card Debt?
First things first, let’s define what credit card debt really is. Credit card debt is an unsecured liability through a revolving loan — meaning your debt is not backed by collateral, and your line of credit stays open as long as you make minimum payments.
Unlike debit cards, credit cards do not pull from the money you already have in an account. Instead, they are small loans you promise to repay when your bill comes due each month. Missed or incomplete payments are where debts can start to add up.
Principal payments, interest, and late fees make up the majority of credit card debt. In addition, credit card interest rates can range from 18 to 28 percent, quickly increasing the debt on overdue cards.
Credit card debt tends to accumulate for the following reasons:
- Only making minimum payments
- Using too many cards
- Carrying a balance
- Missing payments
- Incurring late fees
- Exceeding the line of credit
- Forgetting to track spending
What is a Credit Score?
A credit score is a numerical representation of your creditworthiness based on data from your credit report. Lenders view your credit score to assess how likely you are to pay back your loan on time based on past behaviors.
Your credit report will typically include scores from the three main credit bureaus: Equifax, Experian, and TransUnion. Each reporting agency uses a different formula to calculate your score, so slight variations will exist between them. Your lender takes all into account when evaluating your creditworthiness.
Credit scores range from 300 to 850. Scores above 670 are considered good, and scores above 740 are exceptional. If your score falls below 670, it may be time to assess opportunities for improvement.
Factors that go into evaluating your score include:
- Unpaid debts
- Open lines of credit
- Credit utilization ratio
- Age of credit accounts
- Bill paying history
- Recent credit applications
- Collections, foreclosure, and bankruptcy history
Why do all of these factors matter? Credit scores determine your interest rate and the amount of credit you can receive, affecting your ability to lease a car, take out a mortgage, or open a new credit card. In addition, poor credit scores could impact whether you qualify to rent an apartment or lead to costlier car loans and insurance premiums. So, improving your score as much as possible is in your best interest.
Impact of Credit Card Debt on Credit Score
So, how does credit card debt affect your overall credit score? Credit scores factor in your bill payment history, length of credit history, new lines of credit, types of credit, and credit utilization rate — which are all heavily tied to how you use your credit cards.
Let’s look at three of the most important factors:
- Payment history. Payment history examines if you pay your bill on time and in full. Late and minimum payments can lower your score.
- Credit history. Credit history takes time to build. If you've only had a credit card for a few months, you need more time to get a reputation for creditworthiness. It's good to start building credit early.
- Credit utilization rate. Credit utilization, or your debt-to-credit ratio, is one of the largest factors of your credit score — making up 30% of your grade. Utilization rate compares how much credit you have available to how much you use. Ideally, this ratio should be 30% or less. For example, if you have a credit card with a maximum of $10,000, you should limit your spending on the card to $3,000 before paying it off.
Tips for Managing Credit Card Debt
Reducing credit card debt is one of the best ways to improve your overall credit score. Here are a few strategies for paying off your debt and raising your score:
- Create a budget. Good outcomes often start with a plan. Budget out your monthly expenses to understand your spending, where you can save, and how much you can allocate toward credit card debt payments.
- Make payments on time. If you need help remembering to pay your bills, consider setting up auto payments to prevent late fees and additional costs.
- Pay more than the minimum payment. Carrying a high balance month-to-month rakes up high-interest charges. Make an effort to budget and save to pay more than the minimum until you pay off the card.
- Look into debt consolidation and management programs. If the debt feels too large to handle, reach out for financial assistance. Your local credit union has advisors who can help create a payment plan and consolidate debt in one lower-interest payment.
- Reach out to your credit card company. In some cases, your lender may extend a hardship program to help you manage your debt directly with them.
- Pay off the highest interest card first. Higher interest rates mean more costs. Focus on paying off high-interest cards first to save more in the long run.
- Pay off the lowest balance first. Baby steps, right? If you feel overwhelmed with cards, start paying off the lowest balance. Sometimes it’s easier to start small.
How to Improve Your Credit Score
Reducing your credit card debt will naturally increase your credit score. However, there are a few additional strategies you can follow to raise your credit score:
- Check your credit score. You need to know where you stand. Once you know your credit score, you can decide if it aligns with your financial needs and how to improve it. Many credit cards now offer free monthly credit score reporting as a service. Federal law also entitles you to a free annual report.
- Dispute any reporting mistakes. Accidents happen. If something in your credit report looks inaccurate, you can dispute it. Errors could include fraudulent accounts or oversights.
- Pay all of your bills on time. By now, you know the importance of paying credit card bills on time. But the same goes for your mortgage, rent, car payment, and other monthly charges. Set up autopay where possible and schedule calendar reminders to ensure you pay on time.
- Maintain existing lines of credit. When used correctly, credit cards can benefit your credit score. Maintain your current lines of credit but refrain from opening new accounts as you work to rebuild your credit score.
- Reduce your credit utilization rate. Your credit utilization rate is one of the biggest factors affecting your overall credit score. Work to pay down your cards and limit spending to less than 30% of your line of credit.
When you put in the work, your credit score can improve in around six months. Remember to stay on top of payments, reduce debt, and limit credit card spending to minimize your utilization rate.
Credit Union and Debt Repair Programs
Credit unions and credit repair are compatible in many ways. For starters, most credit unions offer credit counseling and debt repair programs.
Credit counseling is a service that helps people in debt take control of their finances and create a debt relief plan through money management courses and other actions.
Debt management programs typically consolidate debt under one lower-interest loan to reduce interest charges and streamline payments.
Credit unions’ member-oriented approach means you can rely on your credit union financial advisor to have your best interests in mind. From credit-building products specifically designed to establish or rebuild credit to larger financial guidance that helps you see the connection between credit card debt and credit score, your local credit union has you covered.
Further Resources on the Impact of Credit Card Debt on Your Credit Score
Here are additional resources to help you take control of your credit card debt and credit score.
- Know your score. Get your free credit score from the only federally authorized site.
- Get your rate. Calculate your credit utilization rate to ensure you’re at or below the recommended 30% ratio.
- Create a budget. Download a budgeting worksheet to start planning your finances and be intentional with your spending.
The Winning Combo of Credit Unions and Credit Repair
Now that you know how credit card debt affects your credit score, you can focus on the best ways to reduce your credit card debt: pay more than the monthly minimum, pay on time, and reduce your credit utilization rate to 30% or below. Follow these tips for managing credit card debt and improving credit scores, and you'll soon see improvement.
For further support in repairing your credit score, including opening a credit union credit card specifically designed to support building credit, use our Credit Union Locator Tool to find the local credit union nearest you.