Credit Scores: How Much Debt Is Too Much?

December 6, 2004, Reviewed February 4, 2011

How Does Debt Affect FICO Score?

"When I ordered my FICO score, one of the reasons given for my low score was that ‘The amount owed on your accounts is too high.’ Since I own marketable securities that are worth twice as much as all my debts combined, how did they come to this completely unjustified conclusion? And what can I do about it?"

The two major components of a credit score, which on average account for 2/3 of the total score, are payment history and amounts owed. Where the first is a record of how well you have met your obligations over the years, the second is a snapshot of your indebtedness right now. If your credit history is short, your current indebtedness can be the most important factor determining your credit score.

Ordinarily, a financial advisor seeking to determine whether consumers were living within or beyond their means would look at debts relative to assets and income. But the FICO credit scorers don’t have information on assets or income, only on debt. They must make do with that.

The approach they use is to compare the outstanding debt on each of your accounts with the maximum amount of debt that the credit grantor has set for you on that account. This generates a set of "utilization rates" for each of your accounts. For example, if you have two credit cards with maximum balances of $4,000 and $5,000, and if the actual balances are $3,000 on both as of the most recent date of record, the utilization rates are 75% and 60%.

Other things the same, the higher the utilization rates, the lower the FICO score. The FICO genie interprets high ratios to mean that the borrower is living closer to the edge.

Beyond this type of broad generalization, the genie keeps his cards close to his vest. Would two accounts with utilization rates of 75% and 60% generate a higher score than one account with a rate of 75%? Would 4 accounts with rates of 50% each generate a higher score than one account with a rate of 75%? I can’t answer questions like this because Fair Isaac, the company that developed the system, won’t let me look at their formulas.

Fair Isaac does have a simulation routine on their web site where people who buy a copy of their credit score for $12.95 can test various strategies for improving their score. Some people may find it useful for that purpose, but it will not answer the kinds of questions I posed above.

What Information on Debt Does FICO Use?

The data on debt balances used to compile a credit score are reported by credit grantors, and isn’t always correct. That’s why it is a good idea for consumers to check their credit well before they go into the market, giving themselves time to get any errors fixed. Suggestions on how to correct errors can be found at How Do You Correct Mistakes in Your Credit Report, and also on Fair Isaac’s site

But there is another potential problem in connection with the data on utilization rates that borrowers should be aware of. For various reasons, credit grantors do not report maximums on all revolving accounts. Where no maximum is reported, the largest balance ever to be reported on the account is used in its stead. This necessarily results in higher utilization rates for such accounts.

For example, Doe currently has a $1,000 balance on an account on which the maximum is $10,000. Awhile back, Doe had a balance of $2,500, which is a high as it has ever gone. If the maximum is reported on this account, the utilization rate would be 10%, but if it is not, the rate would be 40%. And Doe’s credit score would be lower as a result.

A recent Federal Reserve study indicated that a relatively small number of credit grantors account for most of the cases where maximums are not reported. It also found some tendency for credit grantors to report maximums less frequently for sub-prime borrowers than for prime borrowers.

If you order your credit score through Fair Isaac, you can get a list of all your credit grantors, and their credit limits. If any have no reported limit, you can either request that the limit be reported, or terminate the relationship. In the unlikely event that the credit grantor won’t report the limit but you want to maintain the relationship anyway, you can shift all your balances into this account temporarily so that the highest balance comes closer to the unreported maximum. 

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