Have you ever seen a statement on your credit report that reads “proportion of loan balance to the loan amount is too high”?
Most individuals are unaware of what it is and how to deal with it.
This statement aims to communicate that your credit utilization rate is too high and you need to appropriately manage your finances; otherwise, there may be some problems soon.
The utilization rate is calculated by dividing your current debt by your credit limit. The amount of revolving credit you are currently using (outstanding) is divided by the entire amount of revolving credit available.
Let’s have a detailed understanding of what it means when this statement appears on your credit report.
This statement indicates that you are making higher use of the loan and how much you currently owe (outstanding amounts on installment loans) to the original loan (principal loan) is higher. So, if you want to lower this ratio, you need to lower the outstanding liability.
Further, the overall installment loan utilization rate is determined by the ratio of loan balances to loan amounts (principal).
The outstanding balances on your installment loans are compared to the actual loan amounts to determine your loan utilization rate.
The division of your current loan balance by the original loan amount will give you this ratio stated as a percentage.
In short, this percentage determines how much you are owing on the payments of your installments right now, and lenders commonly use it to determine your creditworthiness.
When you first get an installment loan, your loan debt will be large because you haven’t made much progress toward paying it off.
The loan balance reduces with each payment you make, reducing the loan balance’s proportion to the actual loan amount.
If this ratio is high on your credit report, it simply suggests that you’ve used a loan facility recently. On the other hand, an alternate interpretation might be that you have not paid installments on a timely basis.
It should also be noted that the credit utilization rate is identical to the installment loan utilization rate.
Your credit usage rate, also known as the credit utilization ratio, is calculated by dividing the entire amount of the revolving credit line you’re utilizing by the amount of credit you now have available.
Simply put, it is the amount you owe divided by your existing credit limit, commonly given as a percentage.
Many people believe that deactivating a credit card will halt recurring costs, but the truth is that the balance must still be paid.
Factors that Influence “Proportion of Loan Balance to Loan Amount”
Based on your financial activities and circumstances, various factors can influence your credit score report. We’ll go over some of the most prevalent reasons for higher loan balances to the loan amount.
The Impact of the New Installment Loan
You are not required to repay debt in the beginning. So, with limited payment history, your debt will still be high, resulting in a high loan balance-to-amount ratio. In other words, the increase in loan balance might trigger this statement.
The impact of accounts with a low average age
Balances’ large proportion to the original loan accounts may occur in some situations due to a short average history of accounts.
You are unlikely to be required to repay a considerable portion of the account’s real loan amount with relatively recent funds. It demonstrates a high loan use rate, which raises the likelihood of receiving a statement.
So, if you haven’t taken out a new loan in a while, your high utilization rate is almost certainly related to your accounts’ low average age.
Drawbacks of High Loan Balances to Loan Amounts
Finance Charges That Are Too High
A high loan-to-balance ratio also means that interest and finance charges on those loans will be greater than they would be if the ratios were lower.
Because you’ll have more debt, your interest payments will be greater. It may cause you to overspend if you won’t be careful.
High Probability of Default
Lenders regard you as a greater danger of defaulting on your loans if your loan balances are a large percentage of your total loan amount.
If you have a high proportion of installment loans compared to the amount you originally borrowed, they may refuse to authorize new installment loans.
To compensate for the increased risk of default, some lenders may be required to offer you either less money or raise your existing loans’ interest rates. Hence, it’s advisable to always control the proportion of loan balance to the loan amount.
Credit Scores that are Below Average
One of the most obvious drawbacks of a high loan balance-to-loan-amount ratio is the risk of default. Your credit score is more likely to be low if this ratio is large. There are some self-help strategies available for improving your credit score.
Also, if you’re seeking to clear your installment loan debt, your bank offers a variety of options. You can use a starter’s check, cashier’s or certified check, online banking for payments, an instant check cashing service, or money order.
It figures out what it implies by statement loan balance is higher than the loan amount and when it is stated on your credit report.
Also, you will try to enhance your credit score using some of the information discussed above. If things grow too complicated, weigh the benefits and drawbacks of employing an accountant and talking with a professional.
If you see a statement on your credit score that ‘the proportion of a loan balance to the loan amount is higher, it means that outstanding liability is currently higher, leading to greater financial leverage.
Although, it’s not always due to missing installment payments. It might mean that you have recently raised the finance via a loan that remains payable as of now.
Further, this statement can be taken as a symbol that you need to remain alert with your finance and ensure that due care is taken in managing money.
From the borrower’s perspective, this statement increases default risk as the borrower already has financial commitments to be fulfilled.
Frequently asked questions
Why does the credit limit drop down?
There can be various reasons for the credit limit to go down that include but are not limited to the following.
- You might have missed the payment for the installment.
- There may be some change in the credit limit.
- There may be some hard inquiries on your credit statement.
- An error on your credit report may lead to a drop in the credit limit.
Can we request to remove the error in the credit report?
Yes, you can request the bureau remove any credit report error. This can be done by filing a dispute with the bureau. However, you need to follow the certain procedure prescribed by the bureaus.
How can you improve your credit score?
The credit score can be improved by taking the following steps.
- Always pay your bills on time – Bill payment directly impacts the credit score. If you always pay your bills on a timely basis, it leads to the development of your credit score.
- Pay off your debt on time – Try to repay outstanding liability as soon as possible. It leads to a decrease in utilization ratio and financial leverage.
- Monitor your credit activities regularly – It can be done by checking the credit score from different bureaus. This can be done by regularly reviewing credit bureaus’ credit reports.
- If there are any errors in the credit report, a dispute can be filed to get corrections on the report. However, it can be a lengthy process with specific steps to be taken on a timely basis.