Amount Owed on Revolving Accounts is Too High |
By Kenneth Long on June 9, 2010
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Credit bureaus routinely lower credit scores when a debtor owes too much on credit accounts in general. There is an additional penalty if the amount owed on your revolving accounts is too high.
There is a pretty big distinction in that credit bureaus penalize you more for using most of the available credit on your credit cards than for being maxed out on an installment loan. After all, installment loans begin maxed out and the balance drops according to a repayment schedule known as an amortization schedule.
Revolving credit does not start out maxed. When you open a credit card account, it begins with a zero balance (excluding any annual fees or other junk fees charged by subprime lenders). It builds balances with purchases and finance charges. You of course reduce that balance through your payments.
When a potential lender rejects your credit application because of your revolving debt balances, you should be wary of applying for new credit. You likely cannot handle additional debt if you are already living paycheck to paycheck.
The costs involved with using revolving credit are much higher than most other traditional loans. As such, a smart consumer limits how much revolving debt they accumulate. Instead, they prefer to put off new purchases until after they have paid down their existing balances.
For every dollar that is added in revolving debt, your risk of default slightly rises. The effect is magnified as you use a greater percentage of your available credit.
This default risk is estimated as a function of your credit utilization ratio. This calculation determines what percentage of your revolving credit that you are actually using.
Using less than 10% of your revolving credit limits has negligible if not zero negative effects on your credit scores. Once your balances creep upwards from this, your scores begin to drop. As you exceed 70-100% of your credit limits, your scores really suffer.
Many credit experts advise against exceeding a 30% credit utilization ratio to prevent negative effects on your credit scores. However, according to FICO spokesperson Craig Watts, downward pressure is applied to your credit scores any time debt balances exceed just 10% of your credit limits. This is true for any one account as well as for an aggregate utilization rate.
There is a very dangerous correlation between maxed out revolving credit and defaults. Part of this may represent out of control consumer behavior. The other part is a result of over limit fees that can further put a debtor into distress by increasing their minimum payments.
If you are concerned that you owe too much on your revolving credit accounts, then you should take immediate steps to reduce what you owe. It is time to curb your spending and aggressively pay down your debt.
If you cannot afford to send an extra $100-200 above your minimum payments each month, then you are exhibiting traits of financial distress. Remember that most defaults and bankruptcies begin with simply building credit card balances that you are initially able to manage. Continued spending combined with some other unexpected expense or change in income can quickly send you over the edge if you are carrying large credit card balances.
Credit counseling is frequently recommended for debtors who have accumulated high credit card balances and find themselves unable to repay the debt in a reasonable period of time. Credit counselors sometimes utilize debt management programs which accelerate repayment through lower interest rates that often allow for lower monthly payments.
Join the Discussion at the Credit Forum: How have your high debt balances affected your credit scores?
Amount owed on revolving credit accounts is too high is Code 11 on FICO-based credit scoring products. For NextGen scores, code B5 applies. For more information on credit scoring, see the complete list of credit score factors.
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