Your credit application might get denied if your credit profile is flagged with a common risk code. If you are told the proportion of your loan balances to loan amounts is too high, then you are deemed to be borderline overextended on debt.
| “Proportion of Balances to Credit Limits is Too High” | Credit Score Risk Factor Codes |
| Equifax | 33 |
| Experian | 33 |
| TransUnion | 3 |
| NextGen | P9 |
This is not to say that you are necessarily over your head yet. It does however mean that you are reasonably unable to repay additional debt that you are applying for.
You might be disappointed to be denied new credit. While it may seem like it, you have just received a favor. That lender has refused to extend additional credit that had a high likelihood of default. They did not allow you to take the debt plunge.
That being said, you should take this as a wakeup call that you may be dangerously close to being unable to afford the debt that you already have. Lenders tend to be fairly liberal in extending credit, and often beyond what a reasonable person should take on and still be able to live comfortably.
For example, if a mortgage company approved you for a $200,000 mortgage, that means that you could likely afford that payment if and only if you took on zero additional debt. That means no car payments, no furniture and very little dining out. If you like those things (yes furniture can be useful), then you need to stick with only taking on debt well below your tolerance level.
Major Credit Scoring Factor
Your credit score is composed of major credit scoring components, one of which is responsible for 30% of your overall credit score. Of that 30%, one of the key factors is your credit utilization ratio, calculated as the percentage of your overall credit limits that is free from debt. One major portion of this component measures your credit utilization rate on your revolving accounts. This other risk factor measures how much of your original loan balance is yet to be repaid.
The way that an amortized loan works is that a very small percentage of your initial payments goes towards principal. Most is payable to accrued finance charges. That means that you may have only repaid 12% of your loan balance even though you have made 20% of the payments! You need to have repaid more than a third of your original loan balance before the account will really begin to become a credit builder. That way, your payment history and your account tenure (duration) will provide increasingly positive support for your credit score. The negative effects of still carrying a loan balance will be less and less as the unpaid portion continues to drop.
There is a way to speed up this process of repayment. You can simply make a separate principal payment in addition to your normal monthly payment in order to reduce the balance faster. Of course, you must specify that the extra payment is a principal payment. Otherwise, you may simply be prepaying interest and saving nothing!
Until you have made substantial headway on paying down your loan balances, you should expect your credit scores to be somewhat lower than you would like. As your debt balances become lower percentages of your original loan amounts, the impact of those balances will be reduced. Otherwise, if you still owe most of the original balance, then you may be denied new credit due to having too high a proportion of loan balances to loan amounts.
If you are trying to open new credit accounts because you are having trouble meeting your existing debt payments, then you should understand that new credit will not help you. It will only make matters even worse down the road. Instead, you may wish to experience credit counseling so that you can learn to manage your debt.
Note: Proportion of loan balances to loan amounts is too high is credit bureau risk score reason 33 with Equifax and Experian scoring products. It is risk score reason 3 with TransUnion’s scores. For NextGen scoring products, code P9 applies.
Long is a graduate of the University of North Carolina at Chapel Hill with a B.A. in Industrial Relations. He subsequently received his Certificate in Nonprofit Management from Duke University. His Certificate in Financial Planning was issued by Florida State University.
Long has achieved the Accredited Credit Counselor and Accredited Financial Counselor certifications through the Association for Financial Counseling, Planning and Education. Long originally achieved the Certified Credit Counselor designation through the National Institute for Financial Education.
In addition to years of nonprofit leadership, Long has been an innovator in the field of volunteer tax return preparation programs. He assists volunteer associations and nonprofit organizations who seek to integrate credit counseling and asset-building programs with free personal income tax preparation. His approach to using free credit reports as both an incentive and a screening tool for placement into asset-building programs has been shared with members of the National Community Tax Coalition, the EITC-Carolinas Initiative of MDC, Inc. and nonprofit groups across the Carolinas.
Long assists members of our armed forces in the Carolinas, Iowa, Rhode Island, Georgia and Germany with financial readiness. Please support our Soldiers, Marines, Airmen and Sailors!
Favorite quote:
"The democracy will cease to exist when you take away from those who are willing to work and give to those who would not."
Thomas Jefferson
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