High installment loan utilization hurts your credit score

It's not as damaging as maxing out a card, but it still matters


Speaking of Credit
Speaking of Credit columnist Barry Paperno
Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes "Speaking of Credit," a weekly reader Q&A column about credit scoring and rebuilding credit, for His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
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Question for the expert

Dear Speaking of Credit,
I am getting a dental procedure done and am weighing my payment options. I was wondering how much a new loan of $3,000 will hurt my credit. My score is currently in the low 700s. I have a $0 balance on my credit cards ($13,000 available), a $22,000 student loan ($19,000 still to pay) and a $16,000 auto loan ($14,000 still to pay). I would like to pay the $3,000 off over three to four years. The payments would be very manageable, just concerned about adversely affecting my credit score, as I hope to buy a house in the next few years. Thanks for your time! -- Brian

Answer for the expert

Dear Brian,
A score above 700 tells me that in addition to carrying $0 balances on your credit cards, you've also been making all of your monthly payments on time. Good work!

This also tells me you have got two of the most important sets of scoring elements well under control -- revolving utilization and on-time payments -- leaving some less-critical, but nonetheless important, scoring factors as the culprits for your score not being even higher.

Not that there's anything wrong with a score in the low 700s for most types of credit. But if you're looking to buy a home within the next few years you'll want to raise it to 740 or higher to qualify for the best mortgage interest rates.

With this in mind, I'll explain how you can get there by paying attention to a couple of the less-well-known scoring factors that are probably hurting your score right now. And in answer to your question, we'll see what might happen to your credit score if you open that $3,000 loan.

Average age of accounts
There's a good chance you've been seeing the reason code, "Length of time accounts have been established," accompanying your credit score. If so, you can be sure that one of the main reasons for your score not being higher is that you're coming up short in the length of credit history scoring category that makes up 15 percent of your score. Specifically, this deficiency lies in the scoring formula's "average age of accounts" calculations that divide the total months since the open dates on all of your credit accounts (not collections, public records or inquiries) by the total number of accounts.

Despite not knowing the ages of any of your cards or loans, your relatively high proportion of balances to (original) amounts on all of your open loans indicates short histories for these accounts. And with short account histories comes higher credit risk and lower scores. We'll discuss a score factor that focuses the proportion of loan amounts to loan balances shortly.

How then to extend your average account age and raise your score? It's simple. Just avoid opening new accounts of any kind and you'll begin to see your average age of accounts increase with the passage of time. But what if you take out the loan for dental work? While not the best move for score-raising purposes, you're still not facing too huge a hurdle. All adding that loan will do is cause a slight delay in the score increase you'll eventually start seeing once you stop opening new accounts.

Installment loan utilization
Perhaps you have received the reason code indicating, "Proportion of loan balances to loan amounts is too high," along with your credit score. If so, it's the result of a set of score calculations you probably haven't heard much about, called "installment loan utilization." If you're familiar with revolving credit utilization (card balance/credit limit percentage), you should find it easy to understand how using a formula similar to the one that measures revolving utilization also evaluates the amount you still owe on your loans: current loan balances divided by original loan amounts = installment loan utilization.

Whether evaluating revolving or installment credit, higher utilization percentages always indicate higher credit risk and can lead to lower scores. Also, as with revolving utilization, installment loan utilization calculations fall within the "amounts owed" scoring category that comprises 30 percent of your score. Fortunately, for consumers like you who pay off their credit cards, high installment loan utilization does much less harm to your score than does revolving utilization, which is why your score can be over 700 despite your relatively high installment credit usage.

Why do I say this usage is high? Let's calculate your installment loan utilization, using both your current amounts and a scenario where a $3,000 loan is added. Doing so will help us understand what effect your utilization is having -- and could potentially be having -- on your score:

Before adding the loan:
Loan type
Loan amount
Loan balance
Utilization %
Student $22,000 $19,000 86%
Auto $16,000 $14,000 88%
Total $38,000 $33,000 87%
After adding the loan:
Loan type
Loan amount
Loan balance
Utilization %
Student $22,000 $19,000 86%
Auto $16,000 $14,000 88%
New loan for dental work  $3,000  $3,000 100%
Total $41,000 $36,000 88%

What we see in the first part of the chart above is that you already have quite a high utilization percentage of 87 percent. In the second part of the chart, we see how the addition of a new loan will add only 1 percentage point -- to 88 percent -- a minor temporary increase that monthly payments will quickly bring back down.

What to do going forward?
Considering the likely impacts of the average age of accounts and installment loan utilization calculations on your credit score, if you take on that new loan, expect two things:

  • Your score will drop slightly due to the reduction in your average age of accounts.
  • Your score will experience little or no score impact from the single percentage point rise in your installment loan utilization.

If you don't add that loan, don't open any new accounts and don't add balances to your cards, expect your score to rise that much sooner, as your average age of accounts increases and your installment loan utilization decreases.

Yet even with the addition of that new loan, as long as you continue paying on time, keeping those card balances low and don't open any other new accounts, within the next few years you should have no trouble arriving at that all-important 740 score, and that new home.

See related: How average account age affects your credit score

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Published: March 10, 2016

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Updated: 10-24-2016

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