If you carry a lot of credit card debt, you could be doing damage to your credit rating without even realizing it, even if you've never missed a payment in your life. Credit utilization, or debt-to-credit, is a big factor in how the credit bureaus calculate your FICO scores, so it's important that you understand how it works and manage your bills accordingly.
What is Debt-to-Credit?
Credit utilization, or debt-to-credit, is the amount of debt you have outstanding versus how much credit is still available. For instance, if you have a $1,000 balance on a credit card with a $10,000 credit limit, your credit utilization for that card is low.
On the other hand, if you have a $12,000 balance on a card with a $13,000 limit, you have a high utilization and will appear to the reporting agencies as "maxed out", which is a significant risk factor. It's pretty likely your scores will suffer as a result.
Even worse, if you have multiple cards at or near their limits, you could be doing some serious damage to your scores even if you've never been late on a payment in your life. I've worked with more than a few mortgage borrowers over the years who have perfect payment histories, but fairly low scores because of the high balances on their cards.
Remember, lenders consider debt equivalent to risk. If you already have a lot of debt, it's risky to give you more, so your scores are going to be calculated accordingly.
It's also important to point out that this applies even if you pay your balance in full each month. If you happen to have a high balance on a card at the time a credit report is being run, your scores are going to reflect your financial profile at the time you run the report. The reporting agencies are not going to assume you're planning to pay the balance off in full when the next bill comes, they're going to score your profile based on how it looks at that moment in time.
How FICO Scoring Components are Weighted
The reporting agencies evaluate a variety of things when calculating credit scores, but some components of the calculations are given more weight than others. Check out the following weightings from MyFico.com:
Payment History - 35%
Amounts Owed - 30%
Length of Credit History - 15%
New Accounts - 10%
Types of Accounts - 10%
Notice that debt-to-credit falls under "Amounts Owed", which means it's given quite a bit of weight when your scores are calculated. Based on the weighting it's given, it's pretty safe to conclude that the reporting agencies consider it a major risk factor.
Keep Your Balances Low
If you use your credit cards regularly, it's a good idea to keep your balances below 30% of the limits at all times to help maintain strong FICO scores. This may not matter as much if you're not planning to shop for a mortgage anytime soon, but if you are, it's a good idea to keep those balances down until the new loan is done.
Remember, this applies even if pay off your balances in full every month. A credit report is a snapshot of your credit profile at a particular point in time, so if you have high balances at the time the report is run, even if you plan to pay them in full next month, it could still damage your scores.
FICOs are a big part of qualifying for a mortgage, so it's important to keep them as high as possible. Even a drop of a few points can cost you thousands more in fees and interest over the life of a mortgage - or end up getting your file declined altogether.
If you're planning to shop for a new mortgage in the near future, get yourself set up for the best possible mortgage deal. Keep your debt-to-credit ratio low to help keep your credit scores as strong as possible.
What is Debt-to-Credit?
Credit utilization, or debt-to-credit, is the amount of debt you have outstanding versus how much credit is still available. For instance, if you have a $1,000 balance on a credit card with a $10,000 credit limit, your credit utilization for that card is low.
On the other hand, if you have a $12,000 balance on a card with a $13,000 limit, you have a high utilization and will appear to the reporting agencies as "maxed out", which is a significant risk factor. It's pretty likely your scores will suffer as a result.
Even worse, if you have multiple cards at or near their limits, you could be doing some serious damage to your scores even if you've never been late on a payment in your life. I've worked with more than a few mortgage borrowers over the years who have perfect payment histories, but fairly low scores because of the high balances on their cards.
Remember, lenders consider debt equivalent to risk. If you already have a lot of debt, it's risky to give you more, so your scores are going to be calculated accordingly.
It's also important to point out that this applies even if you pay your balance in full each month. If you happen to have a high balance on a card at the time a credit report is being run, your scores are going to reflect your financial profile at the time you run the report. The reporting agencies are not going to assume you're planning to pay the balance off in full when the next bill comes, they're going to score your profile based on how it looks at that moment in time.
How FICO Scoring Components are Weighted
The reporting agencies evaluate a variety of things when calculating credit scores, but some components of the calculations are given more weight than others. Check out the following weightings from MyFico.com:
Payment History - 35%
Amounts Owed - 30%
Length of Credit History - 15%
New Accounts - 10%
Types of Accounts - 10%
Notice that debt-to-credit falls under "Amounts Owed", which means it's given quite a bit of weight when your scores are calculated. Based on the weighting it's given, it's pretty safe to conclude that the reporting agencies consider it a major risk factor.
Keep Your Balances Low
If you use your credit cards regularly, it's a good idea to keep your balances below 30% of the limits at all times to help maintain strong FICO scores. This may not matter as much if you're not planning to shop for a mortgage anytime soon, but if you are, it's a good idea to keep those balances down until the new loan is done.
Remember, this applies even if pay off your balances in full every month. A credit report is a snapshot of your credit profile at a particular point in time, so if you have high balances at the time the report is run, even if you plan to pay them in full next month, it could still damage your scores.
FICOs are a big part of qualifying for a mortgage, so it's important to keep them as high as possible. Even a drop of a few points can cost you thousands more in fees and interest over the life of a mortgage - or end up getting your file declined altogether.
If you're planning to shop for a new mortgage in the near future, get yourself set up for the best possible mortgage deal. Keep your debt-to-credit ratio low to help keep your credit scores as strong as possible.
About the Author:
Want to buy a house but have some past credit problems? Find out when you can buy a house after a foreclosure or short sale.
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