Credit Scores and Reports

Credit utilization: How this key scoring factor works


Aiming for a high FICO score? Pay close attention to one key ratio: how much you owe against how much credit you have available

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If you’re aiming for a high FICO credit score, pay close attention to how much debt you carry. Credit utilization – the amount you have borrowed compared to your credit limits – is a key ratio.

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.

FICO’s 5 factors

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

  1. How you’ve handled credit (otherwise known as your payment history).
  2. Your credit utilization ratio –how much total debt you have versus how much credit is available.
  3. Your length of credit history
  4. How much new credit you have.
  5. Your credit mix – the variety of loans you have.

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

That’s why consumer experts have a recommendation for cardholders. “Keep credit card balances as low as you possibly can,” said 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,” said Barry Paperno, a credit scoring expert who has worked for FICO and Experian.

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 said.

Credit utilization components

The credit utilization category has six subcomponents:

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

It’s the comparison of amount of debt to a 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.

Plus, FICO considers the total amount of revolving debt across all your credit card limits together as well as individually. So, if you have one card with a $10,000 credit line with a $5,000 balance and another card with a $1,000 credit line and a $200 balance, your total credit utilization ratio across both cards is 47 percent ($5,200 owed divided by total $11,000 in available credit).

Here’s where it also gets tricky: 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 said.

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.

Credit scoring impact of closing card accounts

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 said.

However, when it comes to credit scoring, “Common sense doesn’t always work,” he said.

It’s not only your own actions that can change that utilization ratio for the worse. A 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 nonuse,” McAuliffe said.

“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.”

Ace your credit utilization

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. An old rule of thumb used to say keep your credit utilization below 30 percent, but that’s a myth. There’s no magic about 30 percent. Your score won’t plummet at 31 percent or soar at 29 percent. The real rule? The lower the utilization, the better.

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,” said 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, both your FICO scores may fall.

Pay your balances – frequently

Another recommendation? Consider making payments to creditors more than once each month. Otherwise, if you put a major expense – such as a new appliance – on a credit card, even if you plan to pay it off relatively quickly, 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,” said 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,” Paperno said. “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.”

See related: Sudden spike in credit utilization can cause major score drop, Closing maxed-out card won’t lower credit utilization

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The editorial content on this page is based solely on the objective assessment of our writers and is not driven by advertising dollars. It has not been provided or commissioned by the credit card issuers. However, we may receive compensation when you click on links to products from our partners.

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