Fair Isaac Corporation maintains the formula that calculates the FICO score. This is a three-digit number ranging from 300 to 850 and is looked at as an indicator of the likelihood that you, as a borrower, will become 90 days or more past due on a loan within the next two years. The higher the score, the more likely that you will be current. Debt ratio is an important part of this score.
Considerations
The FICO credit score is based on a number of factors. How many people have looked at your credit and how long you have had credit are two of the smaller influences. Two of the larger influences on your score are making on-time payments and the percentage of utilization or credit-to-debt ratio.
Effects
Most experts agree that using less than 30 percent of your available credit during any monthly billing cycle will help you to keep the highest possible FICO score. This means that if you have $10,000 in total credit lines on all of your credit card accounts, you should not have a balance of more than $3,000 at any time during the month. A less than 10-percent utilization ratio is even better.
Significance
The credit-to-debt ratio or utilization ratio accounts for a significant portion of your credit score. The FICO scoring model says that the credit-to-debt ratio makes up about 30 percent of your FICO score at any time. Paying down your balances to below 30 percent of the total available credit can have a large effect on your credit score.
Warning
Credit-to-debt ratios of 50 percent or more can significantly reduce your credit score. This effect gets worse as the utilization ratio rises. Banks view using a higher percentage of your available credit as a sign that you are not as financially stable, particularly if you have a few cards that carry balances almost at the credit limit.
Misconceptions
Many people think that the credit-to-debt ratio in your credit report is based on your income. This is not true. Credit reporting agencies do not know your income and they do not consider income in their scoring models. Many lenders will ask for income and verification of your income when you apply for certain loans such as a mortgage. The bank then calculates your debt-to-income ratio based on the information you provide.
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