The percentage of Debt Still Owned On Installment Loans
Its the comparison of amount of debt to the credit limit that is crucial.
That ration goes by several names credit utilization ratio, credit-limit-to-debt ratio, balance to limit ration and debt-to-available-credit ratio among them
The math is simple. Its the percentage of how much you owe compared to the amount of your credit limit. If you owe a $100 on your credit card and have a $1,000 credit limit on it, your ratio is 10 percent.
Simple, right? Not always. Here's where it gets tricky:
First of all, FICO doesn't view all account types as being equal. Revolving balances (e.g., credit and retail cards) tend to carry more weight than installment debt (e.g., mortgage, auto and student loans) when amounts owed are considered.
That means that within the amounts owed category, credit cards are the most important type of account for achieving a high FICO score, but they can also do more damage than other types of credit.
Additionally, while you might consider closing an unused or unwanted credit card to be a smart financial decision, because of the way your utilization ratio calculated, the FICO score doesn't see it that way.
As an example, imagine you have two credit cards, each with a $500 credit limit, for total available credit of $1,000.
One of the cards hasn't been used for a while and has a zero balance, while the other card has a balance of $250. That gives you a utilization ratio of 25 percent -- your $250 balance divided by your total $1,000 credit limit. You then close that unused card eliminating the $500 credit limit associated with that account. Now, you've only got $500 in total credit available on that on card but you still have $250 in debt.
Suddenly, your credit utilization ratio has jumped to 50 percent. That change can drag down your FICO Score despite your good intentions. People think closing down your cards was always a good thing.
However, when it comes to credit scoring common sense doesn't always work.
Its not only your own actions that can change that utilization ratio for the worse. The bank may also take steps that have a negative impact on a cardholder's FICO score. Some people hve seen a score go down because an issuer had cut a credit line o closed their card for nonuse.
As in the example above, those changes can make it look like the borrower is closer to maxing out their line of credit, which can weigh on a borrower's FICO score.