How your existing borrowing affects your credit score

Find out how your level of debt might positively or negatively affect your credit score, including your debt-to-limit ratio and debt-to-income ratio.

Key points

  • When you apply for a loan, mortgage, overdraft or credit card, lenders will assess how you use existing borrowing
  • Some lenders may credit score you more favourably if you keep your balance-to-limit ratio and debt-to-income ratio low
  • There are no hard and fast rules as each lender has its own criteria

Whenever you take out any borrowing - be it a loan, credit card, mortgage or overdraft - it gets recorded on credit reports held about you by the three credit reference bureaus, Equifax, Experian and Callcredit.

However, it’s not just these initial applications that get marked down - your borrowing behaviour once you’ve been granted credit also leaves a footprint on credit records.

Future lenders may analyse your existing borrowing when making a decision about whether to grant you credit.

Current borrowing on credit files held about you

If you choose to access a credit report, you’ll find it’s not just your credit applications recorded there.

Lenders also have to regularly record your repayments, missed payments and any extra borrowing so that there’s a clear record of your borrowing activity.

For fixed credit repayments like most types of loans and mortgages, this will hopefully simply show a steadily reducing total.How to improve a credit score

But for more fluid borrowing, like some flexible loan products and credit cards, your activity can be more revealing to future lenders.

Balance-to-limit ratio

Balance-to-limit ratios are applicable to ‘revolving’ credit, which usually means credit cards, where there’s a fixed limit but the consumer controls the balance by spending and repaying.

If you spend more and get closer to your credit limit, your balance-to-limit ratio increases.

If you make repayments and reduce your balance, your balance-to-limit-ratio reduces.

Your balance-to-limit ratio is sometimes also referred to as your credit utilisation ratio.

Some lenders will credit score borrowers more positively if they have a low level of credit utilisation - they’ll want to see that you have credit available to you but that you’re not using it.

Did you know...?

  • Keeping your credit card balance-to-limit ratio below 30-50% may be looked upon favourably by many lenders

There’s no ‘official’ level of credit utilisation that lenders look favourably upon, but keeping your utilisation level under 30-50% may improve your chances of acceptance with many lenders.

Credit reference bureau Equifax told Gocompare.com: “Typically lenders will look at the total amount of credit that an individual has available to them - including the amount already being utilised.

“Using a significant proportion, or all, of the credit available could indicate that an individual is financially stretched.”

This means that, in some cases, it can be a good idea not to cancel old credit cards.

However, that’s not always a good idea either, as Equifax also notes that: “If an individual has an account that they’re not using then it’s important that they shut this account down.

“Some lenders will take into account available credit that an individual already has access to, depending on their own scoring criteria.”

The effect of maxing out credit cards

Although staying within your credit card limit and repaying on time means you won’t incur extra charges, being constantly right up to your credit limit might make it harder to get more credit in future.

That’s because spending right up to the limit can make it look like you’re desperate for more credit when you apply - if you reduce your balance-to-limit ratio before applying for more credit, some lenders may be keener to accept you.How to make your credit card work harder for you

Debt-to-income ratio

Although it’s true that some borrowers like to see that you have credit channels open to you that you’re not using, not every lender will consider this.

Some will instead look at your debt-to-income ratio - and they may take unused yet available credit into account when calculating this.

Debt-to-income ratio is simply the amount of debt you have in relation to your monthly income.

It’s important to note that your income isn’t actually listed on credit reports held about you, so won’t form part of a credit score given by a credit reference bureau for your own information.

However, lenders often ask for details of your salary as part of their application process, so may use debt-to-income calculations as part of their individual credit scoring process.

Debt-to-income and mortgages

Often mortgage lenders will take debt-to-income ratios into account when calculating whether they think you’ll be able to afford repayments.

It’s important to keep your debt-to-income ratio low to show that you’re not overextended or abusing credit

For instance, a lender might have a maximum debt-to-income criteria of 30% - so if your monthly income is £2,000, you’ll be ineligible for the loan if your existing monthly repayments exceed £600.

Credit reference bureau Experian notes that: “Like the balance-to-limit ratio, it’s important to keep your debt-to-income ratio low to show that you’re not overextended or abusing credit.”

Equifax suggests 35% as a guideline maximum debt-to-income ratio:

“To calculate your debt-to-income ratio, add up the monthly payments for all of your debts including instalment loans and credit cards.

“Divide that amount by your total monthly income before taxes have been taken out.

“Ideally, the ratio will be less than 35% including your monthly mortgage payment, and 20% or less if you exclude your mortgage.”How to cut the cost of your mortgage

However, as with debt-to-limit ratios, there’s no set rule.

“There's not a specific percentage of income that individuals should try to limit their level of debt to,” said Equifax.

“Nevertheless, individuals need to ensure that they’re able to keep up to date with all credit payments.

“Any missed payments may make lenders think that an individual is already struggling with debt and therefore could be a negative factor when they apply for new credit.”

How do I know what lenders are looking for?

The bottom line is, when you apply for credit it’s very hard to know exactly what the lender is looking for and how they calculate your eligibility.

Although a useful guideline is to reduce your balance-to-limit ratio and your debt-to-income ratio, there’s no guarantee of whether a lender uses either – or both – of these factors to calculate their decision as each lender has their own credit scoring process.

As well as taking general steps to improve a credit score, you can also use smart search tools that conduct what's known as a soft search of your credit history to check out your chances before applying.

By Derri Dunn