The three-digit credit score is a measure of your financial reliability and acts as the barometer against which financial institutions judge your standing. Compiled as a credit report, several credit reference agencies are responsible for the generation of your credit score. Each time you make an application for borrowing money, your credit score will determine whether you are granted the same.
There are numerous factors which impact your credit score and debt is simply one of them. While the element of debt can act as a substance of benefit if you seek to invest for better future returns, it can quickly turn ugly if left unchecked.
For many people, borrowing may become a lifestyle, which only leads to further debt accumulation, without a consecutive reduction of it.
What Is A Debt Cycle?
Mortgages and student loans are just a few types of loans which may be counted as the good type of debt. However, add to it the burden of credit cards, unwatchful expenditure and payday loans, and it soon turns sour for most.
When debt and its associated costs keep increasing at a pace where a person is unable to pay them off, falling into a debt cycle is imminent. Sometimes, people even borrow more money, simply to pay off what is due.
You may look into getting a small loan to meet your expenses but always spending more than what you earn is certain to trap you into a debt cycle. A regular default in payment of dues is no less than a dreadful situation. In time, it will begin to reflect on your credit score, which will only aggravate your financial problems.
Want to know how a bad debt cycle can be? Read on to find out.
Ways In Which A Debt Cycle Impacts Your Credit Score
A debt cycle can come to impact your credit score in more than one ways. Needless to say, it is a bad idea to fall into one in the first place, but in case you are struggling to make things work, here are some ways in which debt will influence your credit report.
Unpaid Debt Defeats Your Score:
If you thought that debt hardly counts as an element while calculating a credit score, you might be mistaken. Your credit score is greatly influenced by the quantum of debt which you owe to financial institutions.
If you are currently facing a debt cycle, be prepared to be turned down if you approach one of them for an additional loan or pay higher interest rates on the same.
Paying Dues Late Brings Down Your Score:
With a bag full of late EMI payments, you will only stoke the fire on your credit score. It is necessary that you set aside the basic requirement of EMI payments for each month. Failing to do so will amount to default on your dues and poorly reflect on your credit score.
Having No Debt May Not Be Good Either:
If your credit report shows no history of borrowing, do not be under the impression that you are safe from its impact on your credit score. In the absence of any borrowing history, your lenders may not get to know how efficient you are at paying off your dues.
Even if you have an outstanding debt, which is being paid off at the due dates, you can expect a positive impact of it on your credit report.
This is the reason why debt is known as a double-edged sword. When present in the right numbers in your financial portfolio, debt can help to tip your credit score towards the positive side.
Low Debt To Income Ratio Boosts Your Score:
If your debt is on the lower side in relation to your monthly income, you can expect a positive impact from it on your credit score. In this case, what a lender will see is that you have a good inflow of income with you each month. In comparison to it, the amount that you are spending on expenses or repayments of debt sources is less.
This tells your lenders that you are well placed to meet your debt obligations and service them on their due dates. You are more likely to get a loan approval in this case.
Variety Of Debt Increases Score:
Instead of relying on one variable alone, diversity in your debt options further tells your lenders that you are efficient at servicing each one of them. Being able to repay your loans at their due date is a positive indicator of your financial standing.
From the perspective of a lender, a single source of high income but a low balance on a credit card may not be enough to indicate how well you can manage your finances.
These instances highlight a few ways in which a debt cycle can hamper your credit score. Avoiding a debt cycle is the first and foremost solution to this situation, demanding you to take a disciplined stance when you are on the financial ground. Yet, it can be difficult to stay free of debt at some point in life.
This is where the need to adopt several lifestyle habits that can actively keep you out of this trap. Living below your means and avoiding borrowing are some ways in which you can reduce your debt pressure. It is always a good idea to keep a check on your spending pattern by following up on your monthly statements.
You should keep a track of your credit score and report every month so that you are aware of any dip or rise in score. You can check on how to do it here.
Understanding your finances may be easier said than done, but with the right approach, you can avoid a debt cycle and ensure that your credit card score does not suffer. Even if you are at a bad place right now, understand that nothing is permanent.
There are many ways to emerge from a debt cycle and regain control of your finances. While this may occur gradually, you need to understand that the impact of a debt cycle may continue to reflect on your credit score for some time. However, with the right approach and some shift in your habits, you can adopt a positive approach to manage your condition.