Too Much of a Good Thing
Some people believe the more credit they have the better off they are. Have a line of credit or three, multiple credit cards, a car loan or two, a mortgage, it all proves you’re “credit worthy.” After all, they wouldn’t keep throwing credit at you if you weren’t a good risk, right?
I did a search on “having too much credit” only to find multiple sites saying that there was no such thing. One site identified the things that affect your FICO score, pointing out, “… there is no calculation for having too much available credit.” While that may be true for the FICO score, that’s not the only thing that impacts a lender’s decision. And the implication that you can’t have too much credit is bad advice. Is it any wonder people are confused about what they should or shouldn’t do with their money?
Accumulating too much revolving credit – lines of credit or credit cards — makes lenders nervous. That’s because they know that you can access that credit whenever you want. If you lose your job, hit a rough patch at work, split up with your spouse, or just go nuts shopping your little heart out, all that revolving credit is yours for the using. So they treat it as if you’ve already used the maximum when they’re working out your debt service ratio.
Debt service ratio? What the bejezus is that? There are actually two different debt service ratio calculations. The first, Gross Debt Service Ratio, or GDSR, deals with the percentage of your gross income it’ll take to cover your housing costs. But it’s the second one - Total Debt Service Ratio, or TDSR, that I want to talk about.
Your TDSR is the total of your housing along with all your debt payments divided by your gross family income and it tells lenders whether you’re going to be able to pay them back.
Let’s say you go for a mortgage and you have no debt. Your housing costs (mortgage payment, taxes, heating costs, condo fees) will be $1500 a month. Your gross family income is $4,500. Your debt service ratio would be 1500 divided by 4500 multiplied by 100.
1500/4500*100 = 33.33%
Your total debt service ratio is under the acceptable 40% or less level and so you’ll likely get the mortgage.
But let’s say you had a car loan that was costing you $400 a month. You’d have to add that $400 to the equation:
1500+400/4500*100 = 42.22%
That’s over the acceptable limit. Result: You’re declined.
Your car is paid for, and you have no other loans, so you’re in the clear. Or so you think. Do you have any credit cards in your wallet? How many? “Three,” you say. And what are the limits on those cards? “$4,000, $6,500 and $8,300.” So that’s a total of $18,600 in credit
“But I don’t carry a balance” you protest. “I pay my cards off every month. Besides I never even get close to those limits.”
The lender doesn’t care. Since you COULD run those limits to their max, that’s all the lender cares about. So s/he adds in the minimum payment you’d have to make to keep all that credit balanced. Assuming s/he used 2.5% (pretty standard for minimum payments), s/he’d add in $465. Hey, wait a minute. That’s even more than the car payment so there’s no way you’d qualify.
Do you even know what the total of all the limits is on all those cards in your wallet? Considering it’s going to affect the amount you can borrow, shouldn’t you?
If you find you have more cards in your wallet than you actually need - that’d be more than two - then you’re going to have to take some steps to lower your credit exposure and build up your credit attractiveness.
Now, I know there’s a lot of buzz out there about not canceling credit cards because closing accounts can affect your credit rating. And that’s true. When you close your accounts, you wipe out the history of that account, which can affect your credit score and your ability to borrow. Which is one reason why you should hang on to the two accounts that have been most active and have the longest credit history.
You can also call your credit provider and ask that your limits be lowered, as long as you don’t end up pushing against the top of your limit or - heaven forbid - going over your limit, both of which won’t sit pretty with your credit score.
Credit, like everything else in life, has to be managed. It is a tool. You can use it well. Or you can use it to dig yourself a deep, deep hole of disappointment and grief.
May 3rd, 2008 at 3:04 pm
This comment is kind of on topic, about how credit card companies never give you to much of a good thing.
I recently had done a balance transfer of 2500 to a 2.9% promotional rate for 6 months. I thought it was a great way to save some interest.
The card is the one I use just to purchased gas because I save 2 cents a liter and only need to pay for gas once a month.
The problem came when I started to purchase gas. Every month I purchase and pay off about 220 in gas. When I made that payment of 220 it went to the balance transfer and then the 220 worth of gas was then being charged 18.9% until the transfer was paid for.
I am glade this came to my attention by the second months because if I didn’t notice, by the end of the 6th month I would have been paying full credit card interest on half of my balance transfer.
It will now be staying safely on my line of credit until it is paid for!
May 3rd, 2008 at 3:30 pm
GACK! I have one of those “platinum” cards!!!! I got it a few years ago because of the cheap interest introductory rate, and it really was valuable for that since I got a few higher interest loans paid off very quickly and cheaply. Now, although it never has a balance, I am frightened of what that AVAILABLE balance means to any potential loan opportunities.
I guess I need to call them to lower my limit.
May 3rd, 2008 at 3:37 pm
One more thing… I have a “little” credit card that I have had for over a decade… it is used lightly and paid off every month. Is that the credit usage that will keep my credit score healthy? I cancelled my “extra” Master card recently… I never used it, it had no benefits and a huge interest rate… up until I started watching your show regularly I never thought about it much. After all, if it was at zero balance, what harm could it do, right? LOL
May 3rd, 2008 at 8:23 pm
Gail, THANK YOU!!! You did a fantastic job explaining how TDSR works. I’ll be forwarding your blog to my co-workers. It’s a good way to explain it to our clients.
Dan, I’m sorry no one told you how balance transfers worked. They CAN be a fantastic tool to help you lower your interest and pay off your debt faster - but the key is to do it on a card that has zero balance and don’t charge anything else until the balance transfer is paid in full. I’m always careful to explain that to my clients because I think they need to be aware of how it works. It does explain it on the back of credit card statements - but who reads them right?
Tracy: I do believe you’re fine with how you use your *little* credit card. As long as the balance is low it should help your credit score. Paying it in full each month is the best way to go.
May 10th, 2008 at 3:13 am
I have to disagree with you, when I applied for a mortgage no lender was interested in my available credit, none used “hypothetical maxed out cards” in their calculations for my TDSR/GDSR. They were much more interested in the fact that I had a really good credit score, paid my car off early, and paid all credit cards in full, on time, every month.
I wonder if using available credit in calculating ratios is something lenders do when they are looking for a reason to turn down a customer they don’t really want, and something they are willing to overlook when it suits them.
May 31st, 2008 at 3:13 pm
I’ve written a blog post about this, spawned, I assume, by reading this article a few weeks ago ..
.. so now I’m wondering — does anyone have advice on how low to drop those credit limits? I’m sure the answer starts with “well, that depends…”