FICO Credit Score 101: Amounts Owed

This post is part of a continuing series on understanding your FICO credit score, where we delve into detail to explain each component of your credit score calculation. In the first part of this series, you learned that payment history has a huge impact on your FICO credit score. In this post, you’ll learn about the next largest factor in your FICO score, the amounts you owe across your various credit accounts.

Part 2: Amounts Owed (30%)

photo_18980_20101112The next most important contributor, accounting for 30% of your credit score, is the magnitude of the amounts you have owed on your existing credit lines, also known as your utilization ratios. This factor takes into account both the amount owed on all your credit accounts, as well as the amounts owed on each individual account. It can also take into account the actual amount you owe, as well as the relative amount compared to your credit line or usage history.

For example, if you have a credit card with a $5000 line, and you spend $2000 a month, that is a 40% utilization ratio for that card. The optimal utilization ratio is generally below 25-30%. Even if you pay this balance off in full each month, the bank typically reports your statement balance (the number that shows up on your bill). But be careful – if you pay off the whole balance before the end of your billing period, the bank may not report any balance – and that is not necessarily good for you either. Having a low utilization ratio is better than having none at all (or a high one) because it indicates you have managed credit responsibly.

Similarly, the number of accounts with high balances can also impact your score. For example, having five credit cards with high utilization ratios is worse than having 1 credit card with a high utilization ratio.

Owing a lot of money on its own does not necessarily indicate a high-risk borrower, but if you come close to maxing out one or more of your credit lines, lenders may view that as a warning sign you are overextended. So if you are planning a wedding, a big vacation, or some other expensive endeavor, consider spreading the expenses across multiple cards – or even paying off the balance before and immediately after you make that big purchase.

For installment loans, the ratio is typically based on the initial loan amount. Paying down the principal on an installment loan is a great indicator that you are able and willing to repay debt. Of course, this means that when you first take out a loan, the lender may report high utilization ratios until you make enough payments to meaningfully lower the outstanding balance.

Read Part 3 of the series on your Credit History here.

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