If you have a large amount of credit card debt, you could be doing some pretty significant damage to your credit rating without even knowing it - even if you're never late on a payment. Your credit utilization, or debt-to-credit ratio, is major factor in how your FICO scores are calculated by the reporting agencies when you're qualifying for a loan, so it's important that you understand what your debt-to-credit ratio is and manage your debt accounts appropriately.
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 several cards close to their limits (hopefully not over the limits!), you could be doing some devastating damage to your credit scores even if you always pay your bills on time. I've worked with mortgage borrowers over the years who had perfect payment histories, but still had somewhat low FICOs because of the amount of debt they were carrying.
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 worth noting that this applies even if you always pay your balances in full each month. A credit report is a picture of your financial profile at a given moment in time, so if you have a high balance on a card when a credit report is pulled, your scores will reflect it.
How Scoring Criteria is 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%
Your utilization ratio falls into the "Amounts Owed" category, which, as you can see, is given a pretty large weighting when it comes to calculating your scores. Again, even if you pay your bills on time, having a lot of credit card debt can still damage your credit scores pretty significantly. Based on the weighting it's given, it's safe to assume that the reporting agencies consider a high debt-to-credit ratio a significant risk factor.
Keep Low Balances
If you use credit cards on a regular basis, I recommend keeping your balances below 30% of your credit limit at all times to keep your credit scores strong. If you're not going to be shopping for a mortgage anytime soon, it may not matter what your credit utilization looks like right now. But if you do plan to apply for a mortgage in the near future, it's probably a good idea to pay your balances down and keep them there until the mortgage is funded.
Remember, this applies even if you don't roll your balances over from month to month. A credit report is a snapshot of your credit report at a given point in time, so if you have a high balance when the report is pulled, it could tug on your FICOs a bit.
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 mortgage in the near future, get yourself set up for the best deal you can get by keeping your debt-to-credit ratio low. A lower ratio will help keep your FICOs higher and very likely help you land a better mortgage deal.
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 several cards close to their limits (hopefully not over the limits!), you could be doing some devastating damage to your credit scores even if you always pay your bills on time. I've worked with mortgage borrowers over the years who had perfect payment histories, but still had somewhat low FICOs because of the amount of debt they were carrying.
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 worth noting that this applies even if you always pay your balances in full each month. A credit report is a picture of your financial profile at a given moment in time, so if you have a high balance on a card when a credit report is pulled, your scores will reflect it.
How Scoring Criteria is 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%
Your utilization ratio falls into the "Amounts Owed" category, which, as you can see, is given a pretty large weighting when it comes to calculating your scores. Again, even if you pay your bills on time, having a lot of credit card debt can still damage your credit scores pretty significantly. Based on the weighting it's given, it's safe to assume that the reporting agencies consider a high debt-to-credit ratio a significant risk factor.
Keep Low Balances
If you use credit cards on a regular basis, I recommend keeping your balances below 30% of your credit limit at all times to keep your credit scores strong. If you're not going to be shopping for a mortgage anytime soon, it may not matter what your credit utilization looks like right now. But if you do plan to apply for a mortgage in the near future, it's probably a good idea to pay your balances down and keep them there until the mortgage is funded.
Remember, this applies even if you don't roll your balances over from month to month. A credit report is a snapshot of your credit report at a given point in time, so if you have a high balance when the report is pulled, it could tug on your FICOs a bit.
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 mortgage in the near future, get yourself set up for the best deal you can get by keeping your debt-to-credit ratio low. A lower ratio will help keep your FICOs higher and very likely help you land a better mortgage deal.
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