Does Paying Down Debt Increase Your Credit Score?

Paying down debt is one of the best things you can do to improve your credit score and overall credit position. One of the major factors affecting your FICO score computation is debt utilization. This is a comparison of the amount of debt you are currently using as a percentage of your total available credit.

Credit Scores

FICO, named after originator Fair Isaac Corp., is the basis for credit scores reported by Equifax, Experian and TransUnion, the three major reporting bureaus. Credit in use and available credit are included in the amounts-owed category of your FICO score, which accounts for 30 percent of your score, according to the breakdown of the FICO credit scoring model that's posted at the MyFICO website. Credit history and length of credit history make up about half of your score. This includes any late payment marks. The other two categories are types of credit and new credit, with 10 percent contribution each.

Paying Down Debt

Paying down debt means making payments on existing credit accounts, thus lowering your debt utilization on each card as well as your overall debt utilization. Liz Pulliam Weston points out in her MSN Money article "Weird Stuff That Hurts Your Credit" that your FICO score actually rewards credit balances that are smaller and spread across multiple accounts, as opposed to one account with a very high balance.

Debt Utilization Ratio

Lenders want to know what your current credit status is when you apply for a new loan. This is why your debt utilization carries so much weight in the score calculation. Overall debt utilization is important, but your credit score is often most negatively affected if you have a card or two with very high utilization. For instance, a card with a limit of $10,000 and a balance of $9,000 is a very high 90 percent utilization. This appears troubling to FICO and to lenders as well.

Strategy

Based on the relevant benefits to your credit score, Weston suggests paying down cards with high debt utilization ratios before paying off a card with a very low balance. Once all cards are in control, you should pay down those cards with the highest interest rates first. In general, avoiding overuse of revolving credit accounts protects against high debt utilization.