A reader asked if his credit score would improve if he paid off some debt. That depends on what else is affecting your credit rating, so the place to start is by knowing exactly what is on your credit file.
First a useful warning from Experian: There’s no one credit score or magic number – different lenders score differently. Also I would add that the three different credit reference agencies all have their own ways to calculate your score.
I expect you are reading this because you have been declined for credit or you are worried that you may be – so I am going to look at what makes it easier to get credit in general. Your credit score is a big part of this but some lenders have extra criteria so they matter too.
Debt shuffling doesn’t help
In this article, “paying off debt” means paying it off from your income or savings so that you owe less money overall.
Taking out a new loan and using that to clear some credit cards isn’t paying off any debt, it’s shuffling it around. This cuts the interest you pay (good!), but it won’t improve your credit rating.
Have you borrowed “too much”?
If your borrowing is high, then this impacts on your credit score because you will be using a lot of your credit limit – this is often called “credit utilisation”. Your credit score will usually drop if you are using over 90% of a limit on a credit card and gain if you are using under 30%. So if you repay some debt, your utilisation gets better and so does your credit score.
Take the example of Mr A – he hasn’t had problems managing his debt – no late payments let alone defaults. But he has borrowed a lot and his credit cards are maxed out. His credit score isn’t bad, but he’s not sure why it isn’t perfect already and he is upset that he has been turned down for a 0% credit card deal.
If Mr A stops borrowing and starts paying back his debt then his credit score is going to be climbing back to “perfect”, because it sounds as though the only problem he has is too much debt.
If he can concentrate on overpaying the highest interest card, he will also be reducing the amount that goes in interest every month – see A Guide to Snowballing for more details. And after a while he may then be able to get that 0% balance transfer offer, which will speed up his repayments even more.
A few late payments
Lenders don’t like late payments, but they aren’t as bad as defaults or CCJs. In general a lender will mind more about recent late payments because they show you could be struggling at the moment.
Look at Ms B’s case – she was careless with her finances after she left uni and had several late payments four to five years ago but now she has a better job and wants a loan for a car. A lender is likely to be happy to see her debts reducing and may then not care about the old late payments.
If her late payments had been last year, then just starting to pay off the debt may not be enough immediately. But if she carries on repaying debt and not making any extra credit applications though her credit score is going to be start improving slowly – her total debt is falling every month, her “credit utilisation” is improving and the late payments are becoming “older” and they then have less of an affect on your credit score.
Defaults on your credit history
Defaults are much worse for your credit score but they drop off after six years. A previous article Paying a defaulted account and your credit score looked at this in detail and concluded:
- paying large amounts to a defaulted debt so that it gets repaid is a good idea as many lenders will reject a credit application if you have unpaid defaults;
- until the default drops off your file after 6 years, your credit record isn’t going to get to be great;
- starting to pay small amounts may not improve your score but could prevent a CCJ, which would be worse than a default.
Is there anything good on your credit file?
Although credit scores tend to improve as time goes on – because defaults drop off or bad things get older so they matter less – it’s also important to have new, good marks being added.
If your credit record is basically a pile of old, bad marks your score is never going to be good. Even when they go completely, your credit record will just look “thin”, confirming your identity but not having anything positive to say.
This can feel a bit of a dilemma if you have just got yourself out of debt. Not only do you not want to go back into debt, but it’s going to be hard to get credit at a reasonable price. There are some options such Credit Improver but I am not convinced they are worth paying for!
If you need a mobile phone contract that will usually be shown on your credit record and that will help.
The other thing to consider is getting a “bad credit” card, using it every month and repaying it in full every month. These cards can be dangerous, after a year a quarter of all new users have serious arrears… but they are a great tool for credit score repair if you watch out for the sorts of problems that happen with them. These can be a good choice because you don’t have to pay the very high interest if you repay the card each month in full. Other high cost credit such as guarantor loans and payday loans are very bad ways to try to improve your credit score.
So what’s the answer?
Clearing debt improves your chance of getting more credit. If your main problem is that you have too much debt, then paying it off is the only way to improve your rating.
If you have other problems in your credit history then clearing debt will still help as your debt balance is dropping, but it may not have a quick impact. But it stops your score getting worse.