Are you willing to borrow money to buy a pizza?
Facts give consumers greater control of their financial choices.
April 4, 2013 - Author: Wanda J. Roberts, Michigan State University Extension
No matter what you are buying - a home, a car or charging items on your credit card – lenders are interested in the amount of risk they will be taking by lending you money. The FICO score is the standard credit score used to determine more than 90 percent of lending decisions in the United States. FICO stands for Fair Isaac Corporation, which is the company that created the industry standard for credit scores in the mid-1980s.
When a FICO credit score is calculated 30 percent is based on credit utilization ratio. This is basically how much is charged compared to credit limits. For example, if you have a $2,000 balance on one card and a $3,000 balance on another, and each card has a $5,000 limit, your credit utilization rate would be 50 percent. You can find your credit utilization ratio by taking the total amount of outstanding balances on all your credit cards and dividing it by the total of each of your credit card's limits.
So what do you need to borrow money for – fast food, gas, furniture, a pizza?
“Due to the fact that 30 percent of a total credit score is based on a borrower's total outstanding debt, honestly evaluating what you choose to charge is important,” says Jean Lakin, Michigan State University Extension educator. Credit cards are a type of revolving account, meaning it allows a person to borrow as much or as little as they want as long as they don’t go over their credit limit. Revolving debt is weighted more heavily when a FICO score is calculated.
FICO representatives say people with the best scores tend to average about a 7 percent utilization ratio, but that 10 to 20 percent usage is acceptable. This rule of thumb applies to each individual credit card as well as your overall amount of debt.
“The amount of money you owe to lenders is the second most important factor when your FICO score is determined,” Lakin said. Her advice is to keep the balances low – meaning think twice before borrowing money to buy that pair of jeans or grab a burger and charge it to your credit card. If you don’t pay off your credit card balances at the end of each month, it can turn out that you purchased one very expensive burger.
For more information about keeping your family financially healthy, visit MI Money Health.