HOW NOT TO LET DEBT DESTROY YOUR CREDIT

On-time payments are much more important than how much you owe. Credit card users, however, need to take extra care to protect their scores.
Next to late payments, debt is the most likely factor to boost -- or drag down -- your credit scores. But how much will it hurt your credit? And is there anything you can do to salvage your credit while you get out of debt?

First, the good news: the amount of debt you carry isn't nearly as important as how you manage it. "The size of the loan, that's less important than whether it's paid on time," says Sarah F. Davies, senior vice president, analytics, for VantageScore Solutions.

Generally, that's true of all debts, though there is a twist with credit cards we'll discuss in a moment.

Nevertheless, there are some nuances that apply to particular types of loans:

Student loan debt

The average student loan debt tops $24,000 -- and one quarter of borrowers owe more than $28,000, according to the Federal Reserve Bank of New York. While that may feel like a huge balance if you're the one trying to pay it back, it's probably not a huge deal as far as your credit scores are concerned -- provided the payments are made on time.

One of the advantages with student loan debt is that if you owe federal loans and can't make the full payments due, you may have options. Enrolling in the income-based repayment program, for example, won't hurt your scores; again, that's as long as you are keeping up with the payments your plan requires. Similarly, placing your student loan in deferment won't hurt your credit either, though at least with the VantageScore, it doesn't help it, either.

"If the loan is being deferred, then the way we look at that loan is that it's essentially invisible," says Davies. "If (you) had positive performance prior to deferment, then when you put the loan into deferment you will lose the positive payment (history) while it's in deferment." But she adds that once the loan is out of deferment, it will again contribute to the score. "It's only temporary," she says.

Auto loans

Similar to student loan debt, the amount you owe on your auto loans takes a backseat to your payment history on these loans. However, if you're in the habit of buying expensive wheels, or have several vehicle loans with balances listed on your credit reports, that can impact your scores. But again, payment history will trump the amount of debt virtually all the time.

Mortgages

Underwater on your home? That won't hurt your credit score unless you can't keep up with your payments. The value of your house isn't listed on your credit report, so how much you owe in comparison to your home's value isn't an issue. Similarly, you can finance your McMansion with a hefty loan and still maintain excellent credit, provided you make your payments on time. But if you have multiple mortgages with balances, that debt will likely have an impact on your score. (Real estate investors: Beware!)

Credit cards

These loans are treated somewhat differently than the ones mentioned so far, since they are revolving accounts, not installment accounts. While the amount you owe and how many revolving accounts you have with balances are usually taken into consideration, the most important factor here is how much of your available credit you are using. The score will look at your credit limits and compare them to the current balances reported by your card issuers. The result is your "utilization ratio."

Though you may have heard it's important to keep your balances below, say 30% or 25% of your available credit, there's no perfect ratio. FICO reports that "high achievers" – consumers with very high FICO scores – on average use a little less than 10% of their available credit. If you aren't there yet, don't be frustrated: it can always be a goal to work toward.

Does the credit score look at how your debt compares to that of your neighbor, or other consumers across the country? "No. It is based solely on (the individual's) credit file," says Davies, adding that "When we develop and calibrate scores we certainly look at the range of behaviors that exist."

What's a debtor to do?

If you suspect that debt is dragging down your scores, the first thing you need to do is to check your credit reports and credit scores. You can get a free estimate of your credit score using this calculator. In addition to your score, you'll get "graded" on your debt and the other main factors that make up your score, so you can see how your balances are affecting your score overall. You'll also find out how your debt compares to what the average consumer owes.

If you're able to find extra money in your budget to pay down your debt, consider paying down credit cards that are close to their limits first. That may help boost your credit scores, which in turn can make it easier to qualify for lower rates or a less expensive consolidation loan.

But if there is absolutely no wiggle room in your budget, then talk with a credit counseling agency. They may be able to help you lower your interest rates and payments, and get into a Debt Management Plan that will have you out of debt in 60 months or less.
And if that's not even an option, talk with a bankruptcy attorney.

While filing for bankruptcy will have a definite negative impact on the payment history portion of your credit score, it may reset your debt to zero.