I came across this article the other day in which a person asks a staff reporter for CreditCards.com if she pays off her credit card every month, can her score still suffer if that balance is “too high”? The surprising answer is: yes!
Your credit score could be hurt by large balances, even if they are always paid off, so keeping debt levels relatively low may help your family’s scores.
The key to understanding this is the idea of your debt level.
One of the major factors in determining your credit score is the ratio of debt to available credit you have. This is called your debt utilization ratio and it is quite simply a measure of how maxed out are you on your credit cards. For example, let’s say you have an available credit of $10,000, and your monthly balance is about $3,000. This puts your ratio at an nice round 30% – even though you never carry a balance from one month to the next!
Now the problem is also one of timing.
Say that in this example your credit card issuer reports your current balance to the credit bureaus on the 30th of the month, but you submit your payment on the 1st of the following month (still ahead of the due date). Now you apply for a car loan on the 15th and the bank pulls your credit report and sees that you have a revolving debt utilization ratio of 30%. By the way, this would most likely be a perpetual instance, not just for one month – unless you paid your bill much earlier in the billing cycle some months.
Obviously there are other factors involved here as well. For example, your ratio will appear much worse if you don’t have any other credit cards available, or your balance is higher and your credit line lower. In the example above, you’d look like a poor candidate indeed if your credit limit was only $5,000 (you’d have a debt ratio of 60% – $3,000/$5,000. Most financial experts believe that your utilization ratio should be under 30% to maintain an excellent credit score.
Here are some ways to turn this problem around:
- Charge less.
Lowering you monthly balance is a great way to lower your debt utilization ration AND live within your means, though it’s not always easy to do…
- Pay more often.
Most credit card companies let you make multiple payments throughout the billing cycle. The more payments you make, the lower your balance will be at report time.
- Pay earlier.
If you pay off the balance as soon as the statement is available, then you will likely have a 0% utilization when the issuer reports your balance to the credit bureaus.
- Request a higher limit.
This is simple math. Increase the denominator (the number on the bottom – in this case the available credit limit) and you decrease the ratio. The problem is that it may not so easy anymore.
- Open up another credit card – but don’t use it!
Having another credit line can help offset the ratio in much the same way as a higher limit can, since the new credit card limit adds to the available credit you have. As long as you don’t use it, it won’t impact your ratio negatively. But bear in mind that too many credit cards is also a bad thing for your credit score. The sweet spot seems to be about 3 open credit accounts.
A real life scenario.
I was worried about just this sort of thing when I was looking to buy a new home. We put most of our purchases on our family reward card and pay it off every month. But since I have this blog, I’m always keeping up on personal finance news and I knew about the possibility of this sort of timing issue hitting me on my credit report.
I was worried that when I began to shop around for the best mortgage that my debt utilization ratio would get in the way. So, I called my credit card company and asked for a limit increase. This was back in the day when credit was like candy, so they were very willing to do this for me. Also, my utilization ratio was right about on the 30% fence, so it didn’t take much. An increase of $5,000 was enough to put me into the 20% range, and the rest is history – I got a very favorable rate on my mortgage at a wonderful local bank instead of one of the mega-subprime meltdown lenders. 
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