Credit Score Strategy: Paying in Full vs. Credit Limit Increases
There’s this pervasive myth going around that paying off your credit card balance in full each month will score you points (literally) with TransUnion, Equifax and Experian. The fact of the matter is that it won’t. And, in fact, you could even be hurting your credit score by purposefully racking up a high balance and then paying it off before incurring a finance charge. Sound crazy? I’ll explain.
Paying off your credit card balance in full is definitely a good thing. The benefits include:
- Not paying any finance charges.
- Reducing the risk of going into debt.
- Avoiding late or delinquent payments (which DO go on your credit report).
- Being a good customer in the eyes of your credit card company.
I added that obnoxious emphasis to the last point because there is the key difference between building credit and building goodwill with your credit card company. Both are important to your credit score, but in different ways.
FICO Factors – How Punctuality Matters
Payment history eats up a whopping 35% of the pie that makes up your credit scoring factors. But the credit reporting bureaus are only concerned about whether you pay the minimum amount on time. They could care less if you overachieve by paying off your credit card in full each month. That’s because the carrying a credit card balance is part of the agreement between you and your credit card company. You’re not breaking any rules by doing so. While incurring finance charges may be less economical on a personal finance level, it is by no means a penalty and is not indicative of your inability or unwillingness to stick to the terms of your contract. It’s merely a money management choice.
Timing Issues and High Balances
In fact, paying off your debt in full each month may even less beneficial than you thought because of the way the credit reporting bureaus pull your information. The second biggest slice of the FICO pie is amount owed, which takes up 30%. This is a measurement of your credit to debt ratio, or how much you owe vs. how much you can borrow. So, if you pay off your credit card balance every month, that ratio should be very low, right? Nearly zero, even. Wrong.
Let’s say that you have a balance of $1,000 on your credit card with a $2,000 limit and you intend to pay it off on the 23rd. Meanwhile, the credit reporting agencies pull your file on the 22nd. Guess what? It’s going to show up as if you had a 50% credit utilization, even though it would’ve been zero if they would’ve pulled the information two days later. This is an extreme example, but having a credit utilization of 30% or more can bring down your score by 10 to 20 points.
Fixing the Credit Ratio Quirk
It’s not all bad news, especially if you really are in a position to pay off your credit card in full each month. If so, that means that you have reasonable income and assets and probably qualify for a credit line increase. And since you’ve been such a great, responsible customer who has never missed a payment, your chances for getting a credit line increase are even higher.
Extending your credit line will directly help your overall credit to debt ratio. But it also may help to start charging less on your credit card as well. Use some of that cash that you were saving for the end of the month and buy things the old fashioned way until you get your average credit utilization well below 30 percent at any given time. In this way, you’ll be attacking the issue from both ends and you can reclaim some of those stray FICO points that you deserve.
Got a tip for cutting down your credit to debt ratio? Share it in the comments!
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I don’t know about all companies but my experience is that the companies I deal with send my “status” to the credit agencies right after the statement closes each month. That holds for Bank of America, Chase, and my credit union — all of which I have credit cards with. The credit reporting agencies only work with the information they are given. And that information isn’t being sent daily. With some companies you might see it sent more often than once a month, or at a time that doesn’t necessarily line up with your statements or payments, but if they don’t sent information then your credit report won’t get updated.
My utilization is based on the balance on that day and will remain at that amount for the entire period between statements. I pay off my accounts in full each month. In some months, I have paid ahead of the deadline and not used my cards for the rest of the month. My balance at the time the statement came out was 0%. It stayed 0% the entire month even though I was using the card.
At other times, I have had a balance of $500ish when the statement was printed and then spent $600 more in the next couple days. Even though my balance for the next week was over $1,000… my utilization according to the reporting agencies was based on the $500.
If someone is worried about the ratio being reported, they should try and discover when they company usually updates their report. It could be hard unless you are able to pull the report or a report summary on a daily basis. If the company reports the utilization as mine does, they should aim for the balance they want on their reports to be the balance on their card when it closes.
In the $1,000 example given above… sending a pre-payment of $500 would leave a $500/$2000 balance on their report (25%) until the next time the company sent an update.
A possible solution is twofold, one put a credit balance on your credit card to report low utilization for a few months and try to apply for another credit card to lower your utilization or simply have the zero balance before the date, however the author fails to mention that newer versions of fico that take into “charge” cards don’t have the utilization penalty or may take the highest balance you charge making a charge card better or a card that doesn’t have a credit limit.
Since credit reports don’t take into account of your checking and savings accounts, you can apply your savings to credit card debt (if you have savings) to improve your credit score. I would only suggest if you are considering making a big purchase like a used car or 15 year mortgage to receive a lower interest rate.
You can learn a lot about your credit score by going to CreditKarma and updating your score each day. You can see how your score is affected by:
1) When statements are changed on the report
2) How spending affects your score (increase of debt to credit ratio)
2) How reduction of total debt affects your score (decrease of debt to credit ratio)
3) How adding a credit card increases your score (increase debt to credit ratio).