The FICO Algorithm 2/5
In this article I will be focusing on the 2nd most important category that makes up your FICO credit score.
This category is the MOST widely misunderstood, and one of the main culprits for low scores for most Americans.
Luckily for you and I, its the easiest to understand and the easiest to FIX.
As you can see in the graph to the right, CREDIT UTILIZATION is worth 30% of a FICO score.
The lowest score you can have is a 300 (just for being human) and the highest you can have is 850.
So that gives you a total of 550 points to play with. 30% of 550 points is 165 points a person can earn in the utilization category.
Credit utilization ONLY deals with debt owed on revolving accounts… CREDIT CARDS!
That means all credit cards that have revolving terms (meaning it can revolve the debt into the next month) such as chase cards, american express, and store cards such as JC Penny’s and Sams Club.
Therefore, this category has NOTHING to do with mortgage, auto loan, personal loan, student loan, or any other installment loan balances.
Now, let’s talk credit cards. Utilization is very easy to understand but is extremely misunderstood because our parents have preached for an entire generation that credit cards are bad. This is completely false.
BAD spending habits are BAD, but credit cards are necessary to build a great credit score, and to build wealth.
Add up your total credit card limits on OPEN accounts ONLY. Then add up your total balance’s on the accounts and this will give you your total utilization.
Client Jon Doe on the right has $30,000 in OPEN credit card limits and $4,050 of that total balance is being utilized.
You equate utilization by taking the balances/limits. For Jon Doe, his utilization is 17%.
Remember, the utilization category is worth 165 points. 17% of 165 points is 28.. therefore, he losing 28 points in the utilization category just because of credit card balances.
Now how does he get those 28 points back? You might be saying to yourself that the only way would be to pay off the balances. Now, I personally would agree, paying interest on a credit card is not smart. HOWEVER, THERE IS ANOTHER WAY!
Opening more credit cards and adding more limit availability would help the client in close to the same way as paying balances off.
Of course, we teach out clients to never pay a percent of interest. However, if someone truly cant tackle their balances, this is a solid second option.
In this scenario, if this person added 2 more credit cards with $10,000 limits… he would now have $50,000 in total credit limits.
Now he has a 8% utilization ratio. That gave him a 15 point increase.
This client only owes $277 in credit, however, has a staggering 92% in utilization because of her low limits.
Now take a look at this client. He has $30,417 in balances but is only at 17% utilization
Understanding this critical concept will help your credit score climb higher than it has ever been.
The more credit cards you have, the better. Not only for utilization purposes, but because it helps establish banking relationships with all the different creditors to help grow your wealth!
Check out our future blogs and videos on which credit cards are the best cards to open up for your individual credit profile.
Technically any credit card factors into the FICO algorithm the same way, however, if you are interested in getting the best cards with high limits, earning cash back rewards, and learning how to travel for free.. there’s a method to the madness.
Reach out to us at BNB Credit Builders for a free consultation!