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How FICO scores work: Credit utilization

Your credit use ratio accounts for 30% of your score

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This is the second of a five-part series examining what goes in to creating your FICO credit score -- the three-digit number that helps determine how much you can borrow and on what terms. Each part of the series will take an in-depth look at one of the five basic components of the credit scoring model. Today: amounts owed.  

If you're aiming for a high FICO credit score, pay close attention to how much debt you carry.


That's because in the calculation of your FICO score, how much money you owe to lenders is the second most important factor. It's nearly as important as paying your bills on time. But for some consumers, mastering their "amounts owed" can require a somewhat less-than-obvious approach.   

Banks and other businesses use credit scores to predict the odds a borrower will repay a debt, and although many other types of credit scores exist, the FICO score is easily the one most popular with lenders. That means the higher your FICO score, the more likely you are to get approved for loans at a low interest rate with a high credit limit.   

To calculate its score, FICO looks at five different factors:

  1. How you've handled credit (otherwise known as your payment history).
  2. How much total debt you have versus how much credit is available, also called your credit utilization ratio.
  3. How long you've had credit
  4. How much new credit you have.
  5. What types of credit you have.

FICO's scoring model gives a different weight to each of those factors: "Amounts owed" accounts for nearly a third (30 percent) of a FICO score, making it a very important factor for borrowers to understand.    

According to FICO's website, the "amounts owed" information used to calculate a FICO score includes the number and types of accounts a borrower has, as well as how much debt is on those accounts. Another key factor is the comparison between a borrower's available credit and the amount of credit he or she is actually using -- the often-discussed credit utilization ratio.  

That's why consumer experts have a recommendation for cardholders. "Keep credit card balances as low as you possibly can," says Michael McAuliffe, president of nonprofit credit counseling agency Family Credit Management. 

Debt levels matter
Borrowers need to be careful about how much debt they carry if they hope to achieve a high FICO score. FICO's rating system gives borrowers a three-digit score between 300 and 850, with a higher score indicating a borrower who is more likely to repay his or her loans.

Why do debt levels matter so much? "The amount of debt a consumer carries tends to be highly predictive of future credit performance because the amount a person owes has a direct impact on her or his ability to pay all their credit obligations on time each month," says Barry Paperno, consumer operations manager for the company's myFICO.com website. That means taking on too much debt makes it more likely you won't be able to repay your lenders. "While having debt doesn't automatically put someone in a high-risk category, as balances increase, the probability of having difficulty making payments on time each month increases," Paperno says.

Amounts owed components
FICO's "amounts owed" category can be divided into six subcomponents:

  • The amount of debt still owed to lenders.
  • The number of accounts with debt outstanding.
  • The amount of debt owed on individual accounts.
  • The lack of a certain type of loan, in some cases.
  • The percentage of credit lines in use on revolving accounts, like credit cards.
  • The percentage of debt still owed on installment loans, like mortgages.

It's the comparison of amount of debt to the credit limit that is crucial. That ratio goes by several names -- credit utilization ratio, credit-limit-to-debt ratio, balance-to-limit ratio and debt-to-available-credit ratio among them -- but the math is simple. It's the percentage of how much you owe compared to the amount of your credit limit. If you owe $100 on your credit card and have a $1,000 credit limit on it, your ratio is 10 percent.

Simple, right? Not always. Here's where it gets tricky: First of all, FICO doesn't view all account types as being equal. "Revolving balances (e.g., credit and retail cards) tend to carry more weight than installment debt (e.g., mortgage, auto and student loans) when amounts owed are considered," Paperno says in an email. That means that within the amounts owed category, credit cards are the most important type of account for achieving a high FICO score, but they can also do more damage than other types of credit.

Additionally, while you might consider closing an unused or unwanted credit card to be a smart financial decision, because of the way your utilization ratio is calculated, the FICO score doesn't always see it that way.  

As an example, imagine you have two credit cards, each with a $500 credit limit, for total available credit of $1,000. One of the cards hasn't been used for a while and has a zero balance, while the other card has a balance of $250. That gives you a utilization ratio of 25 percent -- your $250 balance divided by your total $1,000 credit limit. You then close that unused card, eliminating the $500 credit limit associated with that account. Now, you've only got $500 in total credit available on that one card, but you still have $250 in debt. Suddenly, your credit utilization ratio has jumped to 50 percent.

That change can drag down your FICO score -- despite your good intentions. "We used to think closing your cards was always a good thing," Family Credit Management's McAuliffe says.

However, when it comes to credit scoring, "common sense doesn't always work," he says.  

And it's not only your own actions that can change that utilization ratio for the worse. The bank may also take steps that have a negative impact on a cardholder's FICO score. "Some people have seen a score go down because an issuer had cut a credit line or closed their card for non-use," McAuliffe says. As in the example above, those changes can make it look like the borrower is closer to maxing out their line of credit, which can weigh on a borrower's FICO score.  

Ace your amounts owed
To improve the amounts owed portion of your FICO score, start by finding out how much credit you have available. Then, pay down balances. If you're a good customer, the banks may also grant requests to increase your revolving credit lines. Experts like McAuliffe suggest keeping debt levels to less than 30 percent of account credit limits.

That can be especially tough for borrowers who only have one account. "If you've got one credit card with a $1,000 line, it's not that hard to hit 30 percent," says McAuliffe, since you'd only need to carry a balance of $300. But if you max out a credit card account by using up an entire line of credit, expect your FICO score to drop by 10 to 45 points.

Another danger comes from joint account holders or authorized users who put excessive charges on your shared card. If the other cardholder maxes out a shared account with a $5,000 limit, for example, your FICO score may fall. To protect yourself, "you've got to have $20,000 in available credit just to balance out that card" and keep your utilization ratio below 30 percent, McAuliffe says.  

Another recommendation? Consider making payments to creditors more than once each month. Otherwise, if you put a major expense -- like a new appliance -- on a credit card, even if you plan to pay it off, your FICO score may take a hit. The reason is that credit scores are calculated as a snapshot in time, so if that happens to be right after you charged a new $700 washing machine, your utilization ratio will look worryingly high. "I'll pay two or three times in a billing cycle, so the billing statement never shows a balance of more than a few hundred dollars," says McAuliffe. In other words, you don't have to wait for the end of the month to pay down your debt.  

In the end, it's a balancing act.

"Having too many accounts with balances can indicate a higher-than-optimal level of credit risk, yet not having any recent credit activity can also be an indicator of increased risk," says Paperno. "A high FICO score can best be achieved by regularly and responsibly utilizing a few accounts of different types, while always paying on time, keeping balances low, and applying for new credit only when needed." 

"It used to be that payments history was the big factor. Now credit utilization is becoming a real issue," says McAuliffe.

See related: How your FICO score is determined: Payment history, How your FICO credit score is calculated: Length of credit history, How your FICO credit score is calculated: New creditHow your FICO credit score is calculated: Types of credit used, 10 things you must know about credit reports, The FICO 5: Breaking down the elements of the FICO score

Updated: April 19, 2013


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