How to Improve Your Credit Score While You’re in Debt

Your credit score doesn’t depend on how much money you make or your checking account’s balance, but it can be difficult to improve your credit while you’re in debt. A good or excellent credit score opens up options. You could apply for a personal loan that has a lower interest rate than your other loans, or transfer credit card debt to a new card with a zero-percent interest rate balance transfer offer. These options might help you get out of debt, but poor credit could disqualify you from these types of products.

If you’re looking for ways to tackle your credit and debt at the same time, consider the following options.

Lower Your Utilization Rate with Strategic Payments or a Credit Limit Increase

The percentage of your credit limit that you use, known as your utilization rate, is an important factor that credit-scoring agencies use to determine your score. Having a lower utilization rate, meaning you only use a small percentage of your available credit, can help improve your credit score.

Heather McRae, a senior loan officer with Chicago Financial Services in Chicago, Illinois, recommends clients that want to build their credit try to decrease the utilization rate on all their revolving accounts rather than focusing on paying down the debt with the highest interest rate. It may not be the most cost-effective way to pay off debt, but it could help you increase your credit score sooner.

That’s because credit-scoring models look at utilization rates in two ways, and both are important. They consider your utilization rate on each individual account and they consider it in the aggregate — looking at the total across all your accounts. There isn’t a magic utilization rate, generally the lower the better, but some people like to aim for keeping their utilization below 30 percent. You could try to achieve something similar across your revolving accounts, then pivot back to repaying the account with highest interest rate.

One way you might be able to speed things up is to ask your credit card issuer to increase the card’s credit limit. Your income and whether or not you have a history of making on-time payments can affect your chances of being approved.

There are some drawbacks to requesting a credit limit increase. The issuer will likely make a hard inquiry to review your credit, which could temporarily have a minor negative impact on your credit score. Also, you may be tempted to make more purchases with the card when you see so much “available” credit. Resist this temptation and remind yourself of your end goal – a higher credit score.

One potentially confusing aspect of utilization rates is that you could pay your credit card bill in full and still have a high utilization rate. The utilization rate depends on the balance that the card’s issuer reports to the credit bureau, not your current balance. Issuers often report the amount you owe at, or around, the end of your billing cycle and it may be equal to your statement balance. Therefore, you may need to make fewer purchase or send an early payment to decrease your utilization rate. The good news is, even if your utilization rate is high one month, as soon as you lower your utilization rate you could see a positive impact on your credit score.

Open a Secured Credit Card

If you don’t already have a credit card, you may want to add a revolving line of credit to your credit mix (a credit-score factor) by applying for a secured credit card. You don’t need to have a strong credit score to get a secured credit card, but you’ll need to leave a deposit with the issuer. Your card’s credit limit will depend in part on your security deposit, and your balance and payment activity with the card will be reported to the credit bureaus.

You can make purchases with secured credit cards just like you can with a standard credit card, and you’ll receive and have to pay monthly statements. Making on-time payments and using a small percentage of your available credit on a secured credit card can help you establish a strong credit record, and improve your score over time.

You may eventually be able to get approved for a standard credit card and close the secured card’s account, or upgrade the secured card to a standard card. In either case you’d get your security deposit back.

Applying for a secured credit card can result in a hard inquiry, which could temporarily hurt your credit score. Secured credit cards also could have higher fees than some standard credit cards, so you might want to switch to a lower-fee standard card as soon as you can. Think of secured cards as a temporary solution, and use them carefully, ideally never carrying a balance from month to month.

Pay with Cash

If you’re having trouble paying down your credit card debts, you may want to stop making purchases with your credit card altogether. This can help lower your utilization rate, and keep you from winding up in more debt.

Breaking the credit card habit can be difficult, though. Some people literally freeze their credit cards in a block of ice in their freezer, others will cut up the cards or leave them at home rather than taking them shopping. Find a method that works for you, and stick with it until you feel enough control that you won’t use the card unless you can pay off the debt when the bill arrives.

Pay Off Recent Collections Accounts

Your payment history is one of the most important factors in determining your credit score, and negative marks such as late payments, accounts in collections, and foreclosures or liens can all have a significant impact.

In some cases, once a negative mark is in your report there’s nothing you can do about it. A negative mark’s effect may decrease over time, but it can take seven to 10 years for it to fall off your report completely. However, the latest versions of the basic FICO Score and Vantage Score, two of the most popular credit-scoring models, don’t hold paid collections accounts against you. Therefore, paying off balances on accounts that have gone into collections could have an immediate positive effect on your credit score.

You might be able to save money by settling the debt for a portion of what you owe the lender or collections agency. However, depending on the scoring agency and model, settlements have a negative impact on your score – albeit a lesser one than owing money on a collections account.

Keep in mind many lenders choose not to use the latest scoring models, and previous versions may view any collections accounts, including paid off ones, as a negative mark. Also, because a derogatory mark’s impact can decrease over time, in terms of your credit score it may not make sense to pay off a collections account that a credit bureau might soon remove from your report. Lastly, be sure to check out this specific advice about paying medical debt in collections.

Ask Your Landlord to Report Rent Payments

Rent payments aren’t traditionally part of your credit history, but you could ask your landlord or property management company to start reporting them. You may need to make payments through a third-party rent-reporting agency, which often charge a fee for processing the payment. Depending on your arrangement, you may need to pay the fee, or the landlord might cover it. Once the rent payments are added to your credit report, some credit-scoring models will take them into account when calculating your score.

Bottom Line

Building your credit can be difficult while you’re paying down debts, but you can do it. Try to focus on the most important credit score factors, such as lowering your utilization rate and making on-time payments, as these can help your credit and reduce your debt at the same time. If you’re looking for a few other specific and actionable tips, consider asking for a credit limit increase, paying off collections accounts, and adding rent payments to your credit reports.

Louis DeNicola is a personal finance writer with a passion for sharing advice on credit and how to save money. In addition to being a contributing writer at Clearpoint, you can find his work on Credit Karma, MSN Money, Cheapism, Business Insider, and Daily Finance.

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