Your credit score is crucial in determining the loan with a credit you can avail of. It provides lenders with an indication of your creditworthiness. A higher credit score makes you eligible for larger loan amounts, higher credit limits, and lower interest rates. However, a poor credit score resulting from a high outstanding debt or a history of missed payments can negatively impact your ability to secure financing.
At Shriram Finance, you can choose from a wide range of credit solutions that can assist you in proper financial management without harming your credit scores. Click here to learn more about the loans offered by Shriram Finance.
In this article, we will understand what outstanding debt means, the types of outstanding debt, and how it impacts your credit score. We will also discuss steps to reduce your outstanding debt to improve your credit score.
What is Outstanding Debt?
Outstanding debt refers to any unpaid balances on borrowed money through loans, credit cards, or financing that you still owe to lenders. It appears as a liability on your balance sheet.
Some common examples of accounts with outstanding debt include:
- Unpaid credit card balances
- Remaining principal on personal, auto, and student loans
- Remaining home loan principal
- Overdue utility bills and cell phone bills
What is Outstanding Debt on Credit Cards?
Outstanding debt on a credit card refers to any unpaid balance carried over after the previous billing cycle. This amount gets added to the next credit card statement for repayment.
Credit card outstanding debt comprises of:
- Purchases made with a credit card but not yet paid off
- Interest charges accrued on the unpaid balance
- Any fees imposed by the issuer, such as annual, late payment, or over-limit fees
- Cash advances have been taken against the credit card
This revolving debt remains outstanding until fully repaid to the card issuer. High utilization and carrying credit card balances month-to-month negatively affect your credit score.
How Does Outstanding Debt Affect Your Credit Score?
Here is an in-depth look at how outstanding debt impacts your credit score:
Unpaid Debt Lowers Your Score
Roughly 30% of your credit score is determined by your total debt amounts and how much you owe. Higher total debt outstanding relative to your income signals higher default risk to banks and lenders. This lowers your overall credit score.
Even if the total debt seems reasonable or manageable, any unpaid debt or missed payments like overdue credit card bills or missed loan EMIs severely hurts your credit score. Such defaults indicate a high risk that you may be unable to repay debts in the future. Therefore, borrowers must promptly repay all outstanding debt accounts before the due date.
Late EMI Payment Reduces Your Score
Making late payments or defaulting on existing loan EMIs can drastically reduce your credit score to 550. Approximately 35% of your credit score depends on your record of repaying debts on time without defaults.
Even a single instance of a 30+ day overdue payment or default on any loan can negatively impact your credit score. To avoid missed payments, set payment reminders for every loan EMI and clear the dues on/before the due date. If facing difficulty in repayment, proactively speak to your lender to restructure the loan terms.
High Credit Utilisation is a Bad Sign
Your credit utilization ratio is the proportion of your total outstanding revolving credit card debt relative to your sanctioned credit limits on cards. A credit utilization percentage of over 30% on cards hurts your credit score, indicating higher risk.
Carrying high balances on credit cards month-on-month compared to your overall credit limit conveys a higher risk of potential payment default to lenders. You should try to maintain low utilization every billing cycle by limiting unnecessary card expenditures and promptly repaying the card bill payments before the due date.
Having No Debt History is No Good
While keeping outstanding debt low is important, having no debt repayment history can also harm your credit score since lenders cannot evaluate your payment behavior.
To build healthy credit reports, consider taking a secured credit card or short-term personal loan and make timely repayments. This provides potential lenders greater visibility into how you service debts and allows them to assess your credit habits.
A Low Debt-to-Income Ratio Boosts Your Score
Your debt-to-income (DTI) ratio measures the percentage of your gross monthly income towards repaying debts. A higher DTI ratio indicates a greater risk of payment default on loans.
Keeping the DTI ratio low by avoiding unnecessary loans and debt obligations helps reduce your risk profile and boosts your credit score. Do not take on excessive debts that strain your repayment capacity relative to income levels.
Having Different Types of Debt Increases Your Score
Lenders prefer borrowers who demonstrate the ability to responsibly manage different types of credit over time. This includes a healthy mix of installment debt like a home, education, and auto loans, and revolving debt like credit cards.
Borrowers with experience managing a diverse credit portfolio across multiple loans and credit instill confidence in lenders about their creditworthiness. It indicates that the borrower can responsibly handle any new credit accounts that may be approved.
Therefore, borrowers should aim to build a varied credit mix by utilizing different credit sources like loans, cards, and financing options sensibly over time. This diversity and good repayment history on different credit accounts enhance their credit score by demonstrating good credit score habits to potential lenders.
Conclusion
Outstanding debt plays a pivotal role in determining your credit score, and its impact on your creditworthiness cannot be underestimated. A high level of unpaid debt, late payments, or excessive credit card balances can significantly lower your credit score, making it challenging to secure loans and financial opportunities. On the flip side, responsible debt management, timely payments, and a diverse credit mix can help boost your credit score, enhancing your eligibility for favorable financial terms.
If you're looking to navigate the complex world of credit and loans while safeguarding your credit score, Shriram Finance is here to assist you. With a wide range of credit solutions designed to promote sound financial management, we empower you to achieve your financial goals without compromising your creditworthiness.
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Key Takeaways
- High outstanding debt lowers your credit score by increasing perceived default risk.
- Missed or late payments on existing debts also hurt your credit score significantly.
- Keep credit utilization low by limiting card use and making timely repayments.
- Try to build a healthy mix of both installment and revolving debts.
- Reduce non-essential spending to free up more cash for repaying your debts faster.
FAQs
1. How do I clear my outstanding credit card debt?
You can clear outstanding credit card debt by paying more than the minimum due every month, transferring balances to a low-rate card, taking a personal loan at lower interest and paying off the card, availing a credit card EMI moratorium, or liquidating assets to repay the dues faster.
2. Does unpaid debt affect credit score?
Yes, any unpaid/outstanding debt severely hurts your credit score. Missed payments signal high default risk. Repay all dues on time; if you cannot repay, speak with your lender to restructure the debt.
3. How long does unpaid debt affect your credit score?
The impact of unpaid debt on your credit score depends on the default type. A missed credit card payment affects your score for up to 6 months. Defaulted loan accounts remain on your credit report for seven years from the date of the first delinquency.
4. Can I build credit with outstanding debt?
It is difficult to build credit if you already have high outstanding debts. Try to reduce your existing dues first before taking new loans. Manage the debts you have diligently before adding new ones.
5. How does debt relief hurt your credit score?
Availing debt relief through settlement or restructuring negatively impacts your credit score as the modified terms reflect your inability to repay as originally agreed. However, it enables you to become debt-free faster.
6. How long does debt relief stay on your credit report?
Debt relief programs like debt management, debt settlement, or bankruptcy may remain on your credit report for up to 7 years from completion or discharge. However, their impact diminishes with time as you build good credit habits.
7. How long does it take to improve credit score after debt settlement?
It can take 12-24 months after debt settlement for your credit score to improve if you begin rebuilding your credit responsibly. Over time, as the settled debt ages on your report, its impact diminishes, and your scores rebound.
8. Will my credit score go up if I settle a debt?
Settling debt for less than the owed amount can negatively impact your credit score in the short term. However, closing settled accounts and continuing to make timely payments on other debts will help improve your score over the long run.
9. What is an example of outstanding debt?
Common examples of outstanding debt include:
- Unpaid credit card balances.
- Outstanding personal or auto loan balances.
- Remaining mortgage principal.
- Only paid utility bills or cell phone bills within their due date.
