Know Your Credit Score: Amounts Owed
In this five-part blog series, we’ll break down the different categories of information that make up your credit score, starting with your “amounts owed”.
Your credit score: It’s important. It’s how lenders decide if they’re going to lend you money, and at what rates. And remaining in the dark about your score is the perfect way to end up at the mercy of predatory payday loans and title loans.
So how is your credit score determined? As it turns out, there are five categories of information that go into it: payment history, amounts owed, length of credit history, credit mix, and recent credit inquiries. We’re going through them one by one.
Today, we’re talking about your “amounts owed”, which makes up 30 percent of your score.
What is “amounts owed”?
Simply put, your “amounts owed” is, well, the amount of money that owe on your various debts, including personal loans, lines of credit, and credit cards. In order to figure out your amounts owed, all you need to do it tally up all the outstanding balances on your loans and credit cards.
With amounts owed, owing less debt is generally considered a better thing than owing more. The only exception to this is if you never use any debt at all: no installment loans, no credit cards, nothing. That can leave you with a “thin” credit history that will hurt your score.
Beyond keeping your debts to a minimum–avoiding large outstanding balances and/or paying down the balances you have already built up–there’s another factor with your amounts owed that needs to be reckoned with.
It’s your credit utilization.
What is credit utilization?
Your credit utilization refers to the percentage of your available credit that you’re using. This won’t matter with your loans, which are issued to you as a single lump sum, but it’ll matter big time with your credit cards.
With credit cards, you are given a credit limit that you can borrow up to. The more money you borrow, the more of your available credit you’re using, and the higher your credit utilization ratio rises.
Credit utilization is also where your amounts owed can start to get a bit tricky.
30 for (keeping it under) 30
“Lenders want you to keep your utilization rate at or below 30 percent,” certified financial educator Maggie Germano (@MaggieGermano) told us. “This means that you should keep your balances below 30 percent of your actual credit limit.”
“Say you only have one credit card with a limit of $1,000, but every month you end up spending at least $750. That means that your credit card utilization is typically at 75 percent. One way to improve this is to make sure you pay off your balances in full each month.”
Paying down your balances is always a good idea because it also keeps you from accruing interest on the purchases you’ve made. The less you have to spend in interest, the more money you’ll have free to put towards things like emergency funds, 401k’s, or sweet dirt bikes.
“If that’s harder for you, consider asking for a credit limit increase,” says Germano. “This will only help you if you don’t increase your spending, though! Keep your spending down, even if your limit is higher.”
Let’s use Maggie’s previous example: If you spend $750 against a $1,000 limit, you’re utilizing 75 percent of your available credit. But if you get your limit raised to $2,000, then that $750 is only utilizing 37.5 percent of your available credit. You’ve improved your credit utilization without changing your spending habits at all!
Like we said, it gets kind of tricky
Seven percent and zero percent
If you are committed to paying down your credit card and loan balances, you will see improvements in your credit score. (This is assuming that you don’t start paying all your bills late or hurting your score in some other way.) And once you get your open balances to a 30 percent utilization rate, that should help your score even more.
But if utilizing 30 percent of your available credit is good, is there a more specific number that’s ideal? According to nationally recognized credit expert Jeanne Kelly (@CreditScoop) When you review people who have 800 scores, they use only seven percent of what is available to them.”
For people who have lots of credit card debt, a seven percent utilization might sound pretty impossible to achieve, but Kelly has additional advice to help you get there:
“If you get balance transfer credit cards to help lower the debt with a 0 percent interest rate, that is the time to truly focus on paying the debt down. Do not close the other account that you just transferred it from. But remember the goal is to not use the cards to build up more debt but to lower it.”
Keeping your old accounts open helps your amounts owed because it raises your total available credit. Credit utilization is judged across all your different cards, so having one old card with a completely open credit line can (and likely will) positively affect your score.
Paying down your debt
If you are able to qualify for those zero percent balance transfers, it’s best to combine them with a solid plan to pay down your debt. The more debt you can pay down while you’re interest-free, the better.
So what’s the best way to do it? There are tons of debt repayment strategies out there, but two of the best are the Debt Snowball and the Debt Avalanche.
With the Debt Snowball method, you order all your debts from the smallest balance to the largest. You put all your extra debt repayment funds towards the debt with the lowest balance, making only the minimum payments on all your other debts.
Once that first debt is paid off, you take all those funds and you put them towards the next debt, working your way up from smallest balance to largest.
Plus, every time you pay a debt off, you add its monthly minimum payment towards your future debts. This way, the money you’re putting towards each subsequent debt gets larger and larger, just like a snowball rolling down the hill.
The Debt Avalanche is structured in much the same way, only you order your debts from the highest interest rate to the lowest, then pay off the debt with the highest rate first.
To learn more about the Debt Snowball and Debt Avalanche, check out these blog posts:
What else can you do?
When it comes to your amounts owed, the simplest advice is also the best: pay down your debts as fast as you can, and then try to avoid taking out lots of debt in the future. The more you stay away from high-interest bad credit loans and no credit check loans, the better!
Depending on your situation, a debt consolidation loan might also be a good option to help you lower your interest rates and pay down debt faster.
“One way to improve your credit utilization is by keeping track of the amounts you charge your credit card. Going over a 30 percent credit utilization will negatively affect your credit score, therefore, if you set up a way to track how much you’re charging to the card, then it’ll be easier to monitor your utilization and keep it low. You can keep track by setting balance notifications or by creating your own credit journal list.”
Pehrson also warns that a credit line increase could result in a hard inquiry showing up on your report. So while it might help your score in the long run, it might cause a smaller rise, or even a small dip, in the short-term.
Since your amounts owed is one of the two largest factors of your credit report–fixing your credit utilization is a great way to get your credit score up.
Tune in next time, to learn about payment history!
|Maggie Germano (@MaggieGermano) is a Certified Financial Education Instructor and financial coach for women. Her mission is to give women the support and tools that they need to take control of their money, break the taboo of discussing debt and income, and achieve their goals and dreams. She does this through one-on-one financial coaching, monthly Money Circle gatherings, her weekly Money Monday newsletter, and speaking engagements. To learn more, or to schedule a free discovery call, visit maggiegermano.com.|
|Jeanne Kelly (@creditscoop) After being turned down for a mortgage 15 years ago, Jeanne Kelly realized she needed to get her credit in order. Not only was she able to fix her bad credit, but she took the skills and knowledge she gained and decided to share it with the world. Now she’s a nationally regarded credit coach and expert, with multiple books and television appearances. Follow her on Twitter and check out her site to get the credit help you need!|
|Alayna Pehrson is a Digital Marketing Strategist and Credit Repair Specialist at BestCompany.com (@BestCompanyUSA).|