Background
How FICO scores view “available credit”
The FICO Score is a three-digit number that summarizes the real-time information on a consumer’s credit report and rank-orders consumers according to their repayment risk. To calculate that risk, the FICO scores assess five categories of the person’s credit history as outlined below. The percentages in this chart reflect how important each of the categories is when calculating scores for the general population
Credit limit information falls under the “Amount Owed” category. Unlike some other credit bureau scores, the FICO score does not consider a consumer’s credit limit by itself. Instead, the FICO score considers the consumer’s credit limit when assessing the person’s “credit utilization rate” — that is, how much available credit is being used at the time the score is calculated.
For example, let’s say that consumer has a credit card with a $20,000 credit limit and a $10,000 balance. The person’s credit utilization rate on that account is 50 percent ($10,000 balance divided by $20,000 limit equals 0.50).
Credit utilization rate has proven to be extremely predictive of future repayment risk, so it is often an important factor in a person’s score. Generally speaking, the higher one’s utilization rate, the greater the risk that person will default on a credit account within the next two years.
How changes in “available credit” can affect FICO scores
If everything else remains the same, we would expect that a reduction in available revolving credit (or the closure of a revolving account) will either have no impact on the person’s FICO score or will cause it to decrease. In reality, the information on credit reports seldom stays the same. People use their credit accounts and they pay their creditors, leading to changes in their reported balances. At the same time consumers also open or close accounts, their existing accounts continue to age, and so on.
When we study credit reports, we find that once a creditor has reduced an account’s credit limit or closed the account, the borrower’s FICO score may go down, it may go up, or it may stay the same. That can be due to one or more of the following factors:
- The amount by which their credit limit is reduced;
- How consumers react to the reduction in credit limit – for example, do they make or miss payments, increase or pay down balances, or open new accounts;
- Other changes in the person’s credit report between the time the account limit is reduced and the time that the creditor reports it to the credit bureau.
What consumers should know to protect their scores
The best advice to consumers in this area continues to be to manage their credit responsibly over time. To help borrowers take actions that will lower their credit risk — and thus raise their FICO score — we recommend the following credit practices:
- Pay your bills on time — Delinquent payments and collections can have a major negative impact on your FICO score.
- Keep balances low on credit cards relative to their credit limits — High outstanding debt can affect a credit score.
- Pay off debt rather than moving it around — A reliable way to improve your credit score is by paying down your revolving credit.
- Don't open new credit cards just to increase your available credit — This approach could backfire and actually lower your credit score.
- Open new credit accounts only as needed — A cautious approach to taking on new credit will help you maintain a good score.
Note that when an account is closed, it doesn’t matter to the FICO score who closed it — you or the lender. Also, even closed accounts will remain on your credit report and will continue to benefit your score when the formula evaluates your length of credit history.