When It Comes to Debt, Does Size Matter?

Big, overwhelming, crushing. Small, manageable, insignificant.

There are many ways to characterize debt, but definitions are relative. What exactly constitutes “a lot of debt”?

“Any debt is too much if you can’t make the payments,” said Credit.com Director of Consumer Education Gerri Detweiler. Missing payments can put a big dent in your credit scores, but throwing a large portion of your income toward debt will hurt your credit, too. “The higher your debt [to income] ratio, the less wiggle room you have to take on more debt.”

Debt size isn’t so much determined by dollar amount as its impact on your finances. When you look at your credit reports and wonder how your debt load influences the way you look to lenders, there are a few things to note.

Beyond the Numbers

Let’s assume you meet the the No. 1 rule of debt — the ability to repay it — and your habit of paying bills on time has had a positive impact on your credit scores. That’s great, because payment history is the most important part of credit scoring. Does the amount of that debt hurt your credit scores?

It depends. In a basic sense, having a large dollar amount of debt isn’t necessarily a negative. Your mortgage, car loan and outstanding student loans may add up to a large sum, but that in itself isn’t going to hurt your scores (again, assuming you have no trouble making monthly payments).

Look at Ratios

Things are a little different when it comes to revolving credit, like credit cards. You have a set credit limit, say $2,000, but that doesn’t mean you should spend $2,000 every billing cycle. Even if you can repay the balance every month, using $1,000 of your $2,000 credit limit will hurt your credit scores, because you’re using too high a percentage of your available credit. Debt usage, or credit utilization, is the second most important factor in determining your credit scores.

There are different numbers tossed out there, but the lower your utilization, the better,” said Experian Director of Public Education Rod Griffin. “VantageScore has recommended no more than 30%. I still think that’s high, but carrying more than 30% is going to have a negative impact on your score.”

VantageScore is one of many credit scoring models used to assess how risky it is to loan money to an applicant. You can see your VantageScore 3.0, as well as your Experian credit score, using the free Credit Report Card, through which you can also see how your debt is impacting your credit portfolio. Keeping your credit utilization low will result in higher scores.

“You have to look at it in terms of your available credit, not just the raw number of the debt,” said Anthony Sprauve, senior consumer credit specialist at FICO, a credit scoring company. “I’m not saying you shouldn’t carry debt, but you have to manage that debt.”

Sprauve also cited 30% as a good threshold, because it’s unrealistic to say you shouldn’t carry any debt.

If you want to take advantage of the convenience and potential rewards offered by your credit cards without bumping up against your credit limit, Sprauve recommended making payments multiple times a month. That way, whenever the credit card company reports your balance to the bureaus, the balance is sure to be low in relation to your available credit.

Of course, if you’re carrying a balance, you shouldn’t be using a rewards card, as the interest rates on those cards tend to be higher, and they may encourage overspending — not a good thing for those in debt.

Credit Scores vs. Credit Applications

The number of your installment loans (mortgages, student loans) won’t hurt your credit scores — in fact, diversity in your credit portfolio is positive — but it could hurt your chances of getting new credit.

Credit reports don’t include income information, but the size of your paycheck is factored into loan decisions. You may be managing your debt very well and keeping your credit utilization low, but if all those bills leave little room for other payments, like a new loan, lenders may reject your application.

Detweiler said a good rule of thumb is to keep your front-end debt-to-income ratio, meaning the amount your existing loan applications take out of your pre-tax income, below 28%. The back-end ratio, which in the case of a mortgage application would include existing obligations as well as the monthly mortgage payment, taxes and insurance, shouldn’t exceed 36%. You can do these calculations yourself, so you know whether or not you need to pay down debt before applying for new credit.

As with many components of credit, the size of your debt matters to a certain extent, but it’s situational. It’s crucial to know how your debt fits into your whole financial picture — and whether you can comfortably repay it.

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