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Why Is Outstanding Debt a Bad Omen For Your Credit Score?

  • Highlights

  • High debt-to-income ratio suggests poor eligibility

  • Unpaid debt reduces your repayment ability

  • Defaults on past payments suggests bad credit management

  • High credit utilisation suggests large outstanding debt

Lenders determine your loan eligibility based on your credit score, which represents your history of debt repayment. A high credit score informs lenders that you’re more likely to make loan repayments on time and in full, and this subsequently boosts your chances at a larger loan amount and possibly lower interest rates as well.

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Here’s a look at how outstanding debt affects your credit score.

Large outstanding debts lower your score

The primary factor that influences your credit score is your outstanding unpaid debt. While you shouldn’t be too concerned about having existing debt on your credit report when you apply for a loan, a large amount of outstanding debt signifies that you are already under financial obligation. Potential lenders take this to mean that you may not be eligible for a new loan or be able to pay it off on time. Regular defaults on loan repayments also lower your credit score.

It makes you look irresponsible with credit

A high debt-to-income ratio reduces your credit score and lowers your eligibility in the eyes of lenders. If you’ve taken on more debt than it is justifiable for you to pay off on your current income, you’re very likely to default on loan repayments in the future as well. Another factor that can severely lower your score is outstanding debts in collections. If you have neglected repaying a past loan, your lender may sell your outstanding account to a collections agency who will then approach you to collect the dues. Paying off collections improves credit score, so it is the first step to getting back on track on your credit.
Additional Read: Documents you need to apply for a debt consolidation loan

It makes you seem credit-hungry

High credit utilisation conveys to lenders that you have a large amount of credit card debt or loan payments to cater to. Maxed out credit cards especially are a big hit to your credit score, since they convey that you tend to take on more debt than you’re capable of paying off. You may find that one of the primary reasons you’re unable to manage your repayments is that you’re juggling numerous debts at once. It is easy for one or two repayments to be neglected as a result; even those can prove disastrous for your credit score in the long-term. In such cases, you may want to consider debt consolidation loan, which lets you pay off all your debts with a single EMI at a nominal interest.

Personal Loan for Debt Consolidation | Bajaj Finserv

It makes you a bad bet for substantial debt without collateral

If your credit score is low and lenders see you as an irresponsible borrower, you may not be eligible for a loan without the security of collateral. This may put you in a precarious position if you do happen to default. Even if you plan ahead, using an Personal Loan EMI calculator to determine that you’re capable of repaying the loan on time given your current financial circumstances, you cannot pre-plan for financial emergencies. A sudden medical emergency may require you to redirect your finances, or you may be terminated from your job without adequate notice. To avoid risking your long-term security when taking on a loan, make sure you’ve cleared as much of your outstanding debt as possible. And ensure you have a contingency fund ready to tackle emergencies.

These reasons outline why outstanding debts lowers your credit score, but remember, when you repay your debt on time, once your loan account is closed, your credit score automatically increases. So, it is important to check free credit report on a regular basis to track the progress.

Building credit history with a mix of unsecured and secured debt is important, as having no credit history leads to a low score.

Bajaj Finserv offers customised pre-approved offers on personal loans to help you consolidate your debt as well as several other financial products. All you have to do is share your basic details and check your pre-approved offer.

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The content of this document is meant merely for information purposes. The personal loan features mentioned in this article are subject to updation, completion, revision, verification and the same may change materially based on policy revisions. For more details, please visit our Personal Loan terms and conditions page here.

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