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Credit Card Debt: Boon or Bane for Your Credit Score?

Credit Card Debt: Boon or Bane for Your Credit Score?

finance
May 17, 2022
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Credit card debt - a nightmare for almost all cardholders can not only leave a bad impact on your peace of mind but also your credit score. Even if it seems super tempting to utilize your entire credit card limit- Resist that urge.

When you max out the credit limit on your card, you are likely to witness a downfall in your credit score. And what happens next? You may end up paying huge interest rates on any other credit card or loan that you get approved. Furthermore, a low credit score can restrict lenders from approving your future loan applications. 

However, without further ado, here let’s take a look at a few commonly asked questions related to a credit card that will help you in better handling one. 

How does paying off debt affect your credit score? 

Paying off your credit card debts is ideal for your credit score. Yes, you read that right. When you pay off your debt, your credit utilization rate (CUR) automatically decreases. So, what exactly is your credit utilization rate? Also referred to as your debt-to-credit ratio, the credit utilization rate is a metric used to determine how much credit you are utilizing compared to how much credit you have in your account.

Here, the good news is the lower your utilization rate, the higher your credit score. As a responsible cardholder, you must aim for maintaining a utilization rate below 30% or even try for a single-digit utilization rate for best results. 

How much credit card debt is bad for your credit score?

There’s no such fixed number to this. Your ultimate goal must be to keep your credit utilization rate less than 30%. 

Since this is a total or “aggregate utilization” that’s measured by your credit score, getting hold of a new card to spread your debt across all your cards to bring down your utilization rate, may not prove to be a great move. It can leave a negative impact on your credit score, as taking out a new card requires lenders to verify your past repayment history or simply put, a credit check of your score, which, in a way, can reduce your credit score. However, if your credit card limit increases, it may not affect it. 

Can paying off credit card debt hurt your credit score?

Paying off your credit card debt that you carried for months might feel relaxing; however, it may not necessarily work in favor of your credit score. Unfortunately, sometimes it can have quite the opposite effect and result in a temporary dip in your credit score. 

In some cases, your score tends to drop because you paid off an installment account way before the due date, which leads to the premature closing of your account. Most lenders are not in favor of this mainly because it ceases their ability to earn interest- after all, it is one of the major ways of money-making. Moreover, it cuts down the number of accounts you have open currently, which is again looked down upon by lenders. As such, your score might go down a bit by paying off an early installment. 

Sometimes, even if you pay off your installment loan on time, you can still experience a drop in your credit score. How? Chances are that it is just some mere coincidence and something else might have caused the same. After all, numerous factors can affect your score, like the application for a new loan or a credit card. 

That said a drop in your credit score is just short-term and temporary, so you need not worry. 

How much time does it take for the credit score to recover again?

There’s no such magic time frame as to when your credit score can recover from a dip, but it will hardly take a few months to go up. Meanwhile, what you can do is:

  • Repay your bills on time
  • Learn what lenders are looking for
  • Prioritize your credit card debts
  • Keep early repayment penalties at bay

Does settling credit card debt affect one’s CIBIL score?

While taking a loan you may have figured out in your mind that you will repay it after a certain period. But at the end of the month, you are unable to meet the repayment commitment due to some unavoidable circumstances. Consequently, you reach out to your bank or lender with your issue and they offer you a choice of One Time Settlement. 

This may seem like a sign of relief to you and you take it up instantly. And then it dawns upon you that your CIBIL score has dropped. 

Always remember, when a bank is writing off a loan, they will report it to CIBIL. One might assume that the relationship between the bank or the lender and the borrower has come to an end, but the CIBIL never fails to surprise you. Rather than closing the transaction, they term it as settled. And when a loan is termed settled, it is seen as negative credit behavior and the borrower is likely to experience a drop in his credit score. 

For over 7 years, the CIBIL holds this record. In the future, whenever the borrower approaches a bank for a loan during that particular period, chances are that the lenders may not agree to sanction the former a loan. Lenders tend to go through the borrower’s past repayment history before considering offering him a loan. So, if the borrower has the settlement in his credit report, the banks and lenders never agree on approving his/her loan request. 

Takeaway

To sum it up, clearing off your credit card debt alone won’t affect your credit score. In fact, it is the various other factors that together add up to bring down the score. 

Another thing you must keep in mind is that paying off credit cards early doesn’t harm accounts, paying off installment accounts does make a difference.