There
are many types of credit that contribute to who we are as consumers.
One category that confuses many people is revolving credit. Revolving
credit is any account listed on a credit profile that a consumer can
choose to pay as little as the minimal amount and charge as much as
desired up to the allowable limit. This includes credit cards,
overdraft on a checking account, lines of credit, and in many cases,
home-equity lines.
In addition to
revolving credit, installment and mortgage credit also define us as
consumers. However, unlike revolving credit, installment and mortgage
credit both have a preset amount that is paid monthly, therefore
consumers decisions are limited to paying on time or not. Revolving
credit on the other hand allows the borrower to make the choice of
maxing out a card and paying as little as desired (not less than the
minimum payment). This is the only type of credit that the borrower
manages most facets of use; deciding what to charge, how little they
will pay back, and whether or not their payments will be on time.
Because borrowers have so much control over revolving credit, lenders
use the history and current states to gather clear insight into the
management skills of the credit holder. Revolving credit balances
therefore have a greater affect on Fico Scores.
Additionally,
most people assume or don't realize there is a limit on revolving
credit accounts even if it's not displayed on the report. It is very
important to be aware that if a high balance is listed on the credit
profile for an account that does not reflect a limit; the high
balance becomes the limit. This can cause a decrease in scores
if the consumer has high balance to limit ratios on revolving credit
and some of those accounts only reflect a high balance as the limit,
especially if the high balance is low.
For example:
John is applying for a $1,200,000 loan and his credit is pulled by
his banker. John's Fico Score is a 710 and he needs a 740 or
above. His five credit cards are listed below with their current
balances and limits:
Amex - balance
$12,000 limit $15,000
Capital One
-balance $19,000 limit $22,000
Citi Card -
balance $450 high balance $600
Discover -
balance $13,000 limit $15,000
Amex - balance
$1000 high balance $1500
John's current
aggregate balance equals $45,450 and his aggregate limit equals
$54,100, leaving him with a balance to limit ratio of around
85%. This means his balances are too high since they are quite
close to his total limit. This is causing his score to drop
about 70 points. The closer your balances are to limits on
revolving credit the higher a risk you are to lenders. This
scenario reflects that he is almost maxed out on the credit he has
the heaviest hand in managing. John is therefore a much higher risk
with his 710 score reflecting such. He cannot get the loan and
his only option is to pay down his balances to increase his credit
score.
If John had been
educated about his credit and scores a year prior to applying for the
loan he might have understood the need to have lowered balances and
higher limits on revolving credit. This would have allowed him to
achieve the score necessary for loan approval. If John was aware of
how credit balances, limits, and high balances work, he might have
decided when making a big purchase for his business, to use one of
his other Amex or Citi Cards. This could have increased his highest
balances substantially. If those two cards had high balances of
$20,000 each, his aggregate limit would have been much higher and his
balance to limit ratio would come in at about 50%, which is much
better than the 85% it reflects now. His score could have been
a 740 or very close to it.
Now John has to
come up with $23,810, verse just a few $1000 he might have had to pay
if he had higher limits, just to pay down his balances in order to
reach the balance to limit ratio he needs to give him the 740
score. At a time where he needs as much cash on hand for loan
approval as possible he has been put in a tighter position and may
not have the funds to maneuver the requirements. The other
choice is to rush out and spend $20,000 on each of the accounts that
show the low, high balances. He would then have to wait a month
for the report to reflect the increased high balance and then make a
payment to bring that balance back down to 40% or 50% of the
limit. This could take two-three months and cause quite a bit
of unnecessary stress and frustration, not to mention expense.
He might even lose the property he had a contract on if it
expires before the loan is approved.
In today's
mortgage world many pending loan approvals could be made less
complicated and have a better chance of success if applicants have a
better understanding of how to prepare for one of the biggest
investments in their lifetime. Feel free to forward this
article to your referral sources, friends, and family.
"Great credit brings great
opportunity!!"
Copyright 2011
