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Understanding Credit Utilization

When reviewing a credit report, consumers need a basic understanding of the elements used to calculate a score.  When using the Fair Isaac Corporation (“FICO”), the most widely used and well known credit scoring system, there are five different factors used to determine a score with each factor contributing a different percentage to your overall number.  These five factors include Payment History (35%), Credit Utilization (30%), Length of Credit History (15%), Type of Credit Used (10%) and New Credit (10%).  While four of these five factors are fairly self explanatory, credit utilization, which accounts for 30% of your score, requires a deeper understanding.  If you are looking to maintain a good credit score, it is a good idea to focus on your credit utilization, or how much debt you are carrying versus your amount of available credit. 

While some consumers will argue that good credit means paying your bills on time, 30% of your score depends on how much of your credit you have actually used.  Just because you pay on time every month, does not mean your credit score will be positive. The amount of debt you carry also matters.  Experts say the reason your level of debt matters is because the amount of debt a consumer carries can predict future credit performance.  In other words, if you are carrying a large amount of debt, there may come a time down the road that you are unable to continue making all of your payments as interest continues to accrue.    

Credit utilization has six parts which contribute to your ratio.  These parts include, the amount of debt owed to lenders; the number of accounts with balances; the amount owed on each separate account; the specific types of loans and debts; the percentage of credit lines in use on credit card accounts; and the percentage of debt owed on mortgage accounts.  When determining your credit utilization, it is your amount of debt compared to your total amount of available credit that matters. This ratio is calculated into a percentage.  The problem with this percentage is that FICO does not treat all accounts equally. For example, FICO gives more importance to revolving accounts, such as credit cards, than it does to installment loans, like mortgages, auto loans or student loans.  In other words, when making an effort to improve your credit score by lowering your credit utilization ratio, start by paying down your credit card balances first.

In an effort to improve your credit utilization ratio begin the process by determining your amount of available credit.  This means take an itemization of every revolving account and installment loan on your report and add the total amount of your credit limits.  Then calculate the total amount you have used or that you owe and use both what you owe and what you can spend to determine your ratio.  The lower your ratio the higher your credit  score.  Experts say that around 30% is an ideal number to aim for.  If you are looking to improve your ratio or percentage of your credit utilization, it will be hard to do with fewer accounts.  Try to keep a few accounts open and use your credit limits wisely.

If you are in need of additional information or assistance regarding your credit report or credit score, contact SmithMarco P.C. for a completely free case review.  

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