• The Credit Cowboy

Utilization Rate

By: Steve Altonian

What determines a credit cards impact on the FICO score; Individual credit card trade lines, or overall credit utilization?  

Actually, both hold different weights, so never rely on one without the other.  You especially need to keep this in mind when & if you advise a client to pay an item down.  If overall credit utilization is shot, paying down a couple items will do little to assist your clients score.  You could also end up with a volatile borrower.

Always remember that Credit scores are determined by both total balance-to-limit ratio, or utilization rate, and balances, as compared to the limits on individual accounts.

Utilization rate is an important indicator of credit risk to lenders. To calculate balance-to-limit ratio, divide the balance by the credit limit for that account. To calculate total utilization, compare total balances to total limits.

A high utilization rate is a sign that your borrower may be experiencing financial difficulty and is a strong indicator of lending risk.  As a result, high utilization hurts client credit scores, and can cause lenders to be reluctant to extend additional credit.

If your borrower has a high balance-to-limit ratio on one card, that negative can be significantly off-set by having a low overall utilization rate. That is why I caution clients against closing unused cards if their scores are low and eliminating that open credit limit might increase their total utilization ratio.

I also highly recommend an overall utilization rate of no more than 30 percent. However, the lower your utilization ratio, the better for your credit scores.

Ideally, balances should be paid in full each month.  But, don't expect paying in full to always lower your utilization. The balance reported is the amount owed when they receive their billing statement.

The only way to have a zero balance is to not use the card for an entire billing cycle, or pay the balance well before the due date so that the billing statement will show a zero balance due.

If FICO scores are not as good as needed to be approved at the best rates, paying down balances is often the best action one can take to improve risk.  If points are at a premium for a client profile, I always advise the client to NEVER use the card above 15% & to pay the balance off completely every month.  This has helped me get those last couple of stubborn points for my Loan Officers & get their borrowers into their dream home..

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