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Will paying off debt help my credit?

If you are looking to improve your credit for the purposes of either peace of mind or to get a loan with a good interest rate, you might be asking yourself, “Will paying off debt will help your credit?” The answer always is “yes.” Here’s why.

Your credit score is comprised of information shared by creditors to three major credit reporting agencies: Equifax, Experian and TransUnion. Your credit score can also be referred to as your FICO score, and basically, it’s a cumulative number that is averaged over the three reporting agencies’ scores to come up with one number upon which creditors base their lending decisions. These three agencies factor in information such as payment history, including if your payments were on time and in the agreed-upon amounts; the total amount you owe currently that it still outstanding (also known as your credit-to-debt ratio); the length of time you have had credit; the types of credit held, such as mortgage loans, credit cards or school loans; and how many new accounts you have opened lately.

If you receive your credit reports, and it is all just too much, consider working with the credit reporting agencies to get anything erroneous removed, plus working with your current creditors to perhaps get your interest rate and penalties reduced, getting the total amount owed reduced, or having your monthly payments reduced to a more manageable amount. Before you make a major decision such as bankruptcy or allowing a mortgage to go into foreclosure, be sure to contact your creditors and lender and let them know your situation. In these strained economic times, they might be willing to take half a loaf (so to speak) rather than no loaf at all.

The answers to the question about will paying off your debt help credit comes in when we talk about the credit-to-debt ratio. Accounting for up to 30% of your credit score, this number tells potential lenders if you are overextended now, or if a new loan will put you over your limit of your ability to repay. If a bank thinks you have too many credit cards, for instance, and does not see how you are paying your current rent, insurance, car payment, student loans, grocery bills and miscellaneous expenses right now, they certainly will not extend a new line of credit.

However, if you pay off some of your credit cards, and get some of your smaller loans and outstanding bills paid off, and then go for your credit scores and a potential loan, you will be a much more viable candidate for credit. Your creditors know that paying off debt helps credit scores. Besides your credit-to-debt ratio being more manageable, creditors will note that you are being responsible by taking so much outstanding debt off your plate, and will make responsible decisions when it comes time for them to get their money back from you. If you are in a position to take out another line of credit, you will also feel better about knowing that you don’t have other monthly payments looming over your budget.

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