When your proportion of loan balances to loan amounts is too high, this is typically the result of maxing out your credit card or having too many variable lines of credit.
The statement is the reason provided when the borrower’s credit utilization rate (CUR) or ratio is too high.
This generally occurs when an application of credit is denied, and federal lending regulations require the applicant to receive an adverse action notice which states the specific reason as to why the applicant was rejected.
The adverse action reason provided in the notice will be either of the following:
- proportion of loan balances to loan amounts is too high
- credit utilization rate is excessive
Both statements mean the same thing, that is, the applicant’s financial situation is not sustainable. The amount owed is quickly exceeding total credit limits.
This reason for denial often parallels a high debt to income (DTI) ratio. Both scenarios indicate the borrower does not qualify for additional credit.
As a consequence, the consumer credit report would also illustrate an applicant who is overextended and is therefore considered high risk.
Does a mortgage affect credit utilization?
Since mortgage payments and monthly rent are considered necessities, they do not directly affect credit utilization.
While some mortgage payments may be considered excessive, the creditor is mostly concerned with the other type of loans driving up the the credit utilization rate.
Nevertheless, monthly mortgage payments are considered, but with far less weight than other types of credit.
Why is credit utilization important?
The credit utilization ratio is important because it illustrates the overall use of credit as well as how this usage is distributed.
High credit usage may be spread over various types of credit. Whether intentional or unintentional, the varying high or low balances on several credit lines or loan types gives the illusion there is less debt than is actually present.
Evaluating the loan and credit line balances in comparison to the overall credit limits and original loan amounts creates an accurate assessment of the debt level and the credit utilization.
Credit utilization is important because the number of credit obligations directly impact the borrower’s ability to repay.
Multiple credit lines with balances may indicate the borrower is subsidizing living expenses with credit and is overspending.
Either situation is a clear indication that taking on additional debt is neither prudent short-term nor is it sustainable long-term.
My balances aren’t high compared to my income
The irony of credit is the more a person has, the less they are expected to need it. This is because large loans and high credit limits are an indication of ability to repay and overall credit worthiness.
High credit usage is an indication of an overreliance on credit and detracts from a borrower’s credit worthiness.
It’s about maintaining balance.
The argument that making a big income offsets high balances is flawed because no one should carry credit card balances month to month if they can truly afford not to. Doing so costs the cardholder monthly with no positive return.
High debt levels are not really mitigated by high earnings; when a job loss or some other life event disrupts, the situation is doubly doomed.
The majority of applicants carry some level of debt. It is the lender’s responsibility to discern how much is too much, whether the situation is short term or long term, and if the applicant’s credit worthiness outweighs the risk.
Borrowers will sometimes apply for new credit when they sense they are getting deeper in debt and notice their balances climbing.
The initial response can be seeking additional credit to create an illusion of space between the borrower and the amount owed.
Excessive debt levels are overwhelming, especially when the debt has been sustained by further accumulation of debt.
The situation does eventually fall apart, unless steps are taken to get it under control.
When is credit utilization calculated?
The credit utilization rate is assessed as part of most application processes. Whether it be software algorithms or human evaluation, it will be included in the decision process when:
- Applying for a new loan
- Applying for a new credit card
- Applying for credit limit increase on an existing credit card or line of credit
How does credit utilization affect your credit score?
Consumer credit score is negatively impacted by high credit utilization. This is because scoring algorithms reflect the parameters established by sound lending practices.
Over reliance on credit is not a healthy financial circumstance, and so scoring algorithms such as FICO and VantageScore deduct points accordingly.
Your credit score is the result of a number of variables, one of which is credit utilization, which is weighted at around 30% and therefore can be quite influential in the overall calculation.
Decreasing your credit utilization from say 30% to 20% may provide a nice boost to your score. Even more so if you are able to decrease it all the way down to 5-10%.
How much of an impact it has on credit score is ultimately determined and controlled by the individual applicant situation.
What is a good credit utilization ratio?
A good credit utilization ratio is usually around 30% or below. This means that your overall credit balance is 30% of your total credit limits.
For example, if your total credit limit is $20,000, then your balance for a 30% credit utilization ratio would be $6,000.
Note that if your balance rises above 30% at any time, ensure that you pay it off every month to keep it at an acceptable rate.
To put things into perspective, individuals who have excellent credit scores, typically keep their credit utilization at or below 10% every month.
How can I lower my credit utilization?
There is no magic potion to creating a healthy financial life. It is the combination of several factors working toward the same goal.
- Stop relying on credit
- Pay off existing debt
- Be sparing about taking on additional debt
- Live within current income and look for ways to increase income
- Shift from being a consumer (spending) to being creative (finding alternatives)
All of these are easier said than done, but all of them are achievable. There are many free resources available online to offer guidance toward long term financial health.
In addition, having knowledge of when your creditor reports to credit bureaus will also help in managing when you should pay off your balance (either in full or to achieve a certain credit utilization) during the statement cycle.
Below is a list of articles outlining the details about when each bank will report to credit bureaus: