Most people don't know what the words authorized user, unsecured debt, or credit utilization ratio means when looking at their credit report.
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Trying to understand your credit report can feel like trying to learn a new language.
Your credit report contains information that explains why your credit score is what it is. Whether you're accessing your credit report for free or using a paid service, it can feel daunting to actually read your credit report, let alone take actions to improve your credit score. But understanding your credit report can help you identify key action items to raise your score.
We asked personal finance coach Dominique Broadway at Finances Demystified for three common terms on credit reports that most people find confusing.
Broadway urges people to learn the difference between secured debt and unsecured debt. Secured debt, like a mortgage or a car loan, is backed up by assets that are used as collateral. For example, a car loan is backed up by a car that a lender can repossess if the borrower misses too many payments.
On the other hand, unsecured debt like personal loans and credit cards don't require any collateral. Broadway says, "Having a healthy mix of different credit types — secured and unsecured debt — can be very important to your credit score." Having different kinds of debt paid off on time on a regular basis may result in a higher score.
An authorized user is a person, typically a family member or friend, who is added to someone else's credit card account. Since average length of open accounts factors into your score, parents may add their children as authorized users on credit cards to give them a head start on building credit.
If you're a parent adding your child as an authorized user on your account, it's important to understand how that can affect your credit. "When you cosign someone else's debt," Broadway tells Insider, "it can affect your debt-to-income ratio."
Your debt-to-income ratio is the amount of debt you have in comparison to your income. A high debt-to-income ratio can negatively affect lenders' decisions to loan you money for a house or a car in the future. If you have an authorized user on your account who is maxing out your shared account, your debt-to-income ratio can be higher.
The authorized user's credit report can be affected negatively, too, if the person who owns the account pays their bills late. "As an authorized user, you're not responsible for the debt," Broadway says, "but it does reflect on your credit report."
Your debt utilization ratio is not the same as your debt-to-income ratio; it is the amount of money you've borrowed compared to the amount of money you're allowed to borrow. For example, if you have $10,000 of available credit and you've used $9,990, your debt utilization ratio is 99%.
Unlike your debt-to-income ratio, your debt utilization ratio always appears on your credit report and "that percentage can have a huge impact on your credit score," Broadway says. She explains that the higher your debt utilization ratio, the more it can negatively affect your credit score.
If you can't afford to pay down your existing debt to lower your debt utilization ratio, Broadway suggests calling your credit card company to see if you qualify for a credit limit increase, which can also lower your utilization ratio.
