A reader asked if his credit score would improve if he paid off some debt. Yes it will, how much it improves will depend on what else is affecting your credit rating, so the first place to start is by knowing what is on your credit file – MoneySavingExpert has a good guide to checking your credit records.
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”?
Lenders don’t like your overall debt level to be too high in relation to your income. So if you repay some debt, this starts to improve.
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 – not only is her total debt dropping every month, but the late payments are becoming “older”.
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 will improve your credit score;
- but until the default drops off your file your credit record isn’t going to get to be great;
- paying 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 improve when bad things disappear (defaults dropping off) or get less bad (defaulted debt being repaid in full) 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. And even when they go completely, your credit record will just look “thin”, basically confirming your identity but not having anything positive on it.
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. Credit Ladder is a new option in 2016 where you can get your rental payments added to your credit record – but I’m not convinced this is going to help much and it could give more problems!
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 use them wisely and watch out for the sorts of problems that happen with them. These are 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 credit score. 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, but it may not have a quick impact. But it stops your score getting worse.