If you carry a lot of credit card debt, you could be damaging your credit rating without realizing it, even if you pay your bills on time. Your credit utilization, or debt-to-credit ratio, is an important factor in how the credit bureaus calculate your FICO scores, so it's important that you understand what your debt-to-credit ratio is and manage your finances accordingly.
What Exactly is Debt-to-Credit?
Your debt-to-credit ratio is essentially the percentage of your available limit that you're borrowing. For example, if you have a $2,000 balance on a credit card with a $10,000 limit, you have a very low utilization for that card.
On the other hand, if you have a $14,000 balance on a card with a $15,000 limit, you have a very high utilization that appears "maxed out" to the reporting agencies. This is a significant risk factor that can damage your FICO scores.
Even worse, if you have multiple cards near their limits, you could be doing critical damage to your scores even if you never miss a payment. I've worked with plenty of mortgage clients over the years who have never missed a payment in their lives, but had fairly low credit scores because of large credit card balances.
Remember, debt equals risk; the more you have, the riskier it is to lend to you. If you have a lot of debt, the reporting agencies are going to rate your credit profile accordingly.
It should also be pointed out that this applies even if you pay your balance in full every billing cycle. Remember, a credit report is a picture of your financial profile at the time the report is run. If you happen to have a high balance on a card at the time a report is run, your scores will reflect how your credit profile looks at that moment in time.
How Credit Criteria is Weighted
The credit bureaus evaluate a variety of factors when calculating credit scores, but some factors are given more weight than others - including your debt-to-credit ratio. 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 Used - 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.
Maintain Low Balances
If you use credit cards on a regular basis, it's important to maintain your balances below 30% of the credit limit at all times to keep your FICOs strong. It may not be as big a deal to do this if you're not planning to shop for a mortgage anytime soon. However, if you do plan to apply for a mortgage in the near future, it's a good idea to keep your balances down until the new loan is finished.
Remember, this applies even if you don't carry over balances from one month to the next. A credit report is a snapshot of your profile at a given point in time, so if you have high balances on your cards at the time the report is run, it could drop your FICO scores.
FICO scores are a big consideration when lenders qualify you for a mortgage, so you want them as high as possible. Even a reduction of a few points could end up costing you thousands more in fees and interest over the life of a mortgage - or disqualify you 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 Exactly is Debt-to-Credit?
Your debt-to-credit ratio is essentially the percentage of your available limit that you're borrowing. For example, if you have a $2,000 balance on a credit card with a $10,000 limit, you have a very low utilization for that card.
On the other hand, if you have a $14,000 balance on a card with a $15,000 limit, you have a very high utilization that appears "maxed out" to the reporting agencies. This is a significant risk factor that can damage your FICO scores.
Even worse, if you have multiple cards near their limits, you could be doing critical damage to your scores even if you never miss a payment. I've worked with plenty of mortgage clients over the years who have never missed a payment in their lives, but had fairly low credit scores because of large credit card balances.
Remember, debt equals risk; the more you have, the riskier it is to lend to you. If you have a lot of debt, the reporting agencies are going to rate your credit profile accordingly.
It should also be pointed out that this applies even if you pay your balance in full every billing cycle. Remember, a credit report is a picture of your financial profile at the time the report is run. If you happen to have a high balance on a card at the time a report is run, your scores will reflect how your credit profile looks at that moment in time.
How Credit Criteria is Weighted
The credit bureaus evaluate a variety of factors when calculating credit scores, but some factors are given more weight than others - including your debt-to-credit ratio. 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 Used - 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.
Maintain Low Balances
If you use credit cards on a regular basis, it's important to maintain your balances below 30% of the credit limit at all times to keep your FICOs strong. It may not be as big a deal to do this if you're not planning to shop for a mortgage anytime soon. However, if you do plan to apply for a mortgage in the near future, it's a good idea to keep your balances down until the new loan is finished.
Remember, this applies even if you don't carry over balances from one month to the next. A credit report is a snapshot of your profile at a given point in time, so if you have high balances on your cards at the time the report is run, it could drop your FICO scores.
FICO scores are a big consideration when lenders qualify you for a mortgage, so you want them as high as possible. Even a reduction of a few points could end up costing you thousands more in fees and interest over the life of a mortgage - or disqualify you 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.
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