NEW YORK, NY / ACCESSWIRE / October 29, 2024 / Being in debt does not disqualify you from getting emergency loans, but the existence of that debt may have lowered your credit score, which in turn could limit your borrowing options. Most lenders base loan approvals on an applicant's credit score and credit history. One of the best ways to improve your chances of approval for a personal loan is to pay down debt and improve your credit score. In this article, we'll explain how to approach paying down debt.
How Debt Affects Your Credit Score
Credit scoring was developed to help lenders assess risk. Loan applicants with a history of late payments and large amounts of debt owed are considered "high risk." Credit scores measure this using a combination of variables, including "amounts owed" and "payment history," among others. Having significant debt increases the value of the amounts owed category.
Another factor that lenders consider is debt-to-income (DTI) ratio. Credit scoring models, like FICO[ML1][JO2], don't use DTI, but they do look at "credit usage," which is the total amount owed versus total available credit. Think of a credit card with a $1,000 limit. Using $900 of that is high credit usage. Using $100 of it is low credit usage. That's reflected in the "amounts owed."
Other variables used in credit scoring are credit mix (when a consumer has different types of debt like credit cards, personal loans, or auto loans), evidence of applying for a lot of new credit, and length of credit history.
Strategies for Paying Down Debt
There are several ways to pay down debt. Two of the more popular methods are called "debt snowball" and "debt avalanche." A third technique is "debt consolidation."
Debt Snowball
The debt snowball approach is simple: continue making all minimum payments due each month on all debts but keep add an extra amount every month to the account with the smallest balance - until it's paid off. The extra amount can be anything more than the minimum monthly payment, and it can vary each month if cash flow makes that necessary. Once the smallest balance is paid off, take what you were paying on that debt each month and add it to the monthly payment for the debt with the next smallest balance. Continue this process as you pay off each debt.
Debt Avalanche
The debt avalanche method is like the debt snowball technique, but the first focus is on the account with the highest interest rate. With this method, you may not be paying off your debts as quickly as you would with the debt snowball method, but you may end up paying out less overall by saving on interest.
Debt Consolidation Loan
The third strategy involves a debt consolidation loan. In this case, the individual takes out a personal installment loan and uses the funds to pay off higher-interest loans or credit card debt. Successfully paying off the debt consolidation loan could also end up being a great way to help improve your credit score.
The Bottom Line
Being in debt does not necessarily prevent you from getting an emergency loan. It also doesn't mean you're blocked from getting a personal loan to consolidate debt. However, being deeply in debt could translate into a lower credit score and limit your options for possible lenders. Still, by doing your research you'll find there are lenders available that may be willing to lend to you even if you have less-than-perfect credit. Just be sure to take the time to compare fees, interest rates, and loan terms offered by lenders because they can differ. And some lenders allow you to check if you pre-qualify for a loan without impacting your credit score. [ML3][JO4]
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SOURCE: OneMain Financial
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