How Your Debt to Credit Ratio Effects Your FICO Score

There are several factors that go into the FICO score equation, one of the most important is your debt to credit ratio. It is more simply put as your percentage in debt. It is calculated by dividing your balances by your account limit. This is better known in the FICO score formula as your utilization. The percentage of weight it carries is 30% and is the second largest portion of your FICO score. 

 

The reason for its importance and weight has to do with the goal of credit scoring. A credit score’s role is to provide lenders a quick and easy way to evaluate your credit worthiness. Lenders use it to measure risk and default and this is why it is 30% of the formula. There is a large correlation between individuals that are near their limit and default. You can imagine if you are near your limit there is a reason and it is more than likely because you are not in the best financial situation. 

 

There are two different ways utilization is calculated. The first is to add up all your credit balances and divide that be the sum of all your credit limits. The second is done just on an account by account basis. This is important to recognize because a common method to get out of debt is to use credit card debt consolidation. This will not change your total utilization but will drastically effect your account utilization. So even though you have not got more in debt, this method has the potential of hurting your FICO score. 

 

A common rule you will here is to stay under 50%. This is good but won’t qualify you for an excellent credit score. These have an even lower debt to credit ratio and is usually seen as being below 30% or 20%. 

 

A way you can always improve this portion of the equation is to pay down your debt. Well, this is more easily said than done with a high percent of the country carry debts in excess of $10,000. This is a long term goal that will take discipline in spending and budgeting.

Source by William Lathrop

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