Would you rather:
- Save $12 per year?
- Save $1,045 per year?
Go ahead, think it over. Consult with your family. I’ll wait.
[Taps foot. Looks at imaginary watch.]
“I have a question, Paula.”
Yes?
“$1,045 is 87 x greater than $12.”
Yes. Um, that’s not a question.
“Does saving $1,045 require 87 x more time, effort or hassle?”
Great question, my invisible friend. The answer is no. The move that saves $1,045 per year requires — at best — equal effort, and at worst, roughly 30 minutes per month (a pay rate of $174 per hour).
“How do I save $12 per year?”
Order tap water instead of a $1 Coke when you’re at lunch.
“And I can save $1,045 with a roughly similar amount of effort?”
Yep.
“Then I’d prefer Option B.”
Great choice. Now let’s talk about your credit score.
“BOR – IIING! Credit scores? What a snoozefest.”
Hold it right there, buddy. Taking control of your credit score is one of the most crucial moves in Mastering Your Money. The difference between a “Good” score vs. an “Excellent” score — as you’re about to see below — can save you $31,366 over the span of a 30-year mortgage, which works out to $1045.53 per year.
“Whatever. Credit is Snooza-palooza.”
Okay. Here’s a YouTube video of puppies dancing to Gangnam Style.
“Hehehehe. That’s awesome.”
Now that that’s out of your system, are you ready to talk about saving thousands — not just a few measly bucks?
“Alright, fine. Hit me.”
Let’s begin.
Why This Stuff Matters
First, let’s chat about why credit is a crucial weapon in your Awesomeness Arsenal. This chart says it all:
Read that column on the left like a report card: A, B, C, D and F.
You might think that “Good” means “Good,” but it’s akin to getting a “C.” It’s a passing grade — barely. Anything less could knock you out of the running.
And unlike your third-grade report card, which (ahem, let’s face it) doesn’t really matter in the real world (at least, not as much as they led us to believe it would), this “C” carries expensive consequences.
In the world of credit, “Good” — rather than “Excellent” — results in tens of thousands in additional interest over the life of a loan.
In the example above, Average Joe buys a $300,000 house. He slaps a 20 percent downpayment onto the table, borrowing the other 80 percent. If his credit score is “Excellent,” he pays $180,477 over the life of the loan.
If his credit score is merely “Good,” however, he pays an extra $89 per month in pure interest, and shells out an unnecessary $31,366 over the span of his mortgage (hence the $1,045 per year). Ouch.
The moral of the story: Your credit score matters.
Here’s how to improve it.
Credit Basics
Five factors determine your credit score:
35% Payment History
This is self-explanatory: pay your bills on-time. One single late payment can damage your score. Also, the longer you’re overdue (30 days, 60 days, 90 days, 120 days), the worse.
The best hack: Automate it. Set all your cards to “pay in full” monthly. (If you can’t pay in full, at least auto-pay the minimum monthly. Then quit using your cards until you can pay them in full.)
30% Amounts Owed
This is the “trick question” of credit reporting.
Credit bureaus look at your “debt utilization ratio” — how much you owe, relative to your total limit. If your credit limit is $10,000 and you owe $2,000, you’re utilizing 20% of your limit. Ideally, you want to stay at 10% or less.
Here’s the catch: This ratio is measured by the amount you charge, even if you pay your bill in full every month. In other words, you could be debt-free, pay $0 in interest, use your credit card as a proxy for cash — and yet still hold a damaging utilization ratio. This is mega-important, so I urge you to re-read this paragraph.
Don’t worry, you can work around this with two clever hacks:
- Ask your credit issuers to raise your limit. This organically drops your utilization ratio. I ONLY recommend this for people who never carry a balance.
- Pay your bill weekly (or daily). I love getting credit card rewards, especially airline miles, so I charge everything to my card. But to make sure my utilization ratio stays ultra-low, I pay my credit card in full roughly once a week. (This also naturally protects me from overspending).
- If I buy a big-ticket item, I’ll pay the card in full that same day (sometimes while the charge is still “pending.”)
- I automate “pay in full” on every card as a backup — a failsafe mechanism to preserve my payment history.
15% Length of Credit History
This is also self-explanatory: the older your accounts, the better.
Do you carry old credit cards that you rarely/never use? (I have an old student credit card, for example, that I opened when I was a college freshman. I don’t use it anymore because it offers terrible rewards.) Don’t cancel these accounts; they skew your “average account age” to a more impressive number.
The best hack: Keep a small recurring bill on these cards — like your Netflix subscription — and set up monthly auto-pay in full. Your account will stay open and active, and you won’t need to worry about a thing.
10% Credit Inquiries
Every time you apply for new credit, your score gets dinged. (Ironic, isn’t it?)
Ideally, keep your number of new inquires to less than 2 per year.
10% Account Mix
There are two types of credit:
- Installment — You pay fixed, regular installments. Examples: Mortgage, auto loan.
- Revolving — You have an open line of credit. Examples: Credit card, HELOC.
All else being equal, lenders like to see a mix of both, and installment credit is more favorable than revolving.
How to Hack Your Score (in Five Sentences)
Are you familiar with the 80/20 principle? This states that you’ll get 80% of your results from 20% of your effort. In other words, focus your time and energy on the most critical stuff; let go of the rest.
Only three factors — your payment history, utilization ratio and average account age — comprise 80% of your credit score. Focus on keeping those three things as awesome as possible: automate paying on time, raise your limits, keep old accounts open.
(The 80/20 Principle, by the way, is why it’s fine to spend $1 per month on a Coke instead of tap water — as long as you move the needle in major ways. YOLO!)
How to Check Your Score for Free
There are two things you should read: Your credit report and your credit score.
Three bureaus issue your credit report: Experian, Equifax and TransUnion. Each will show you your report once a year for free. Here’s how to systematize it:
- Create three calendar reminders, spaced 4 months apart: January, May, September.
- At each 4-month interval, check your report (for free) from one of the three bureaus. It doesn’t matter which order, as long as you check it from each bureau once a year.
For an easier hack:
- Go to annualcreditreport.com (free) and check your report once a year. (NOTE: Don’t go to copycat sites. If a website demands your payment info, run away.)
This will show you your credit report, but it won’t tell you your credit score.
Until a few years ago, it was next-to-impossible to see your score for free, but fortunately this has changed.
There are a handful of websites that will (legitimately) show you your free score, without bait-and-switching you into some unwanted monthly recurring bill. I personally use Credit Sesame, as you can see from the screenshots I’ve posted here. (Full disclosure: they are a sponsor for this website.)
Myths About Credit Scores
Myth: Carrying a balance will improve your score.
Fact: At best, it’ll have a neutral response (no impact). At worst, it’ll damage your score due to keeping you at a higher utilization ratio.
Myth: Getting unnecessary debt (a car loan, a student loan) will improve your score. You should get one purely for the sake of boosting your credit, even if you don’t need the loan.
Fact: Applying for this loan will damage both your average account age and your credit inquiries, which collectively comprise 25% of your score. Yes, it’s nice to have some installment loans on the books, but that’s only 10% of your score.
Basic math: If you damage 25% of your score for the sake of improving 10% of your score, what happens? Anyone? Anyone? …. That’s right, net damage! In other words, this does more harm than good. Plus, it’s a waste of your money.
Myth: If you pay your bill in full every month, you don’t need to worry about “amounts owed.”
Fact: Wrong-o. Your utilization ratio is based on the statement balance reported to the credit bureaus monthly — regardless of whether or not you carry that balance over to the next month. In other words, even if you pay in full, you could still have a damaging utilization ratio (“amounts owed.”)
Myth: Closing your credit card improves your score.
Fact: Closing cards damages both your average account age and your utilization ratio. Keep old accounts open. Put a tiny payment on them — a stick of gum, once every six months — just to keep them active.
Myth: You’re penalized for checking your credit score.
Fact: You’re only penalized for “hard inquiries” — applications for credit and inquires from outside parties. Checking your own credit score constitutes a “soft inquiry,” which doesn’t hurt you.
Myth: Your income affects your credit score.
Fact: Your income is irrelevant, other than its indirect role in qualifying you for a loan. Your utilization ratio — amounts owed relative to credit limit — affects your score.
Myth: Once you close a credit card or account, it disappears from your credit report.
Fact: All credit cards and accounts, open or closed, stay on your report for a predetermined number of years (typically 7 to 10 years.)
“I’m Anti-Credit Score.”
There’s a vocal minority of anti-debt crusaders who don’t believe in credit scores. Their premise is that if we’re committed to debt-free living, then credit shouldn’t be a concern. Let’s chat about that idea.
“What if I plan on living a debt-free life?”
I’ve never held a car loan, credit card balance or any other debt — so for many years, I thought credit scores didn’t affect me. I understand where you’re coming from.
But there are two instances when I rely on my credit score: Buying a home (or in my case, buying several houses, all of which are cash-flow-positive investments) and earning frequent-flyer miles that cover my international flights.
Even if you prefer to live a debt-free (and a credit-card-free) existence, most people use credit at least once in their life: when buying (or refinancing) a home. And as the chart at the beginning of this article shows, that’s where the difference between “Good” vs. “Excellent” can result in tens of thousands of dollars in avoidable interest.
“Not me. I plan on buying all my houses in cash.”
Until you reach that point, you’ll need a credit score to rent a home. Landlords scrutinize your credit, myself included. I’ve seen the credit scores of all my tenants.
You might also need it to get a job, since many employers also check your credit score — especially if you’re applying at a large company, for a government position, or for anything that needs a security clearance.
“Not me. I’ll write my future landlord/employer a letter, explain that I’m credit-free, and ask him to consider alternative criteria.”
Wow, you enjoy complicating your life, don’t you? Why not just build a score?
“Because I’m a conscientious objector to the tyranny of credit scores.”
Alright. It’s your party. Just don’t email me in 6 months, telling me you’re upset because the employer/landlord declined your request for special treatment, so you missed the opportunity to land your dream job/home.
“That’s a small price to pay for defending my ardent anti-credit-score beliefs.”
Okay.
“You’re not going to argue?”
If you accept that your choices have consequences, and you’re okay with living with the ramifications, then more power to you. The world needs both pragmatists and idealists. You’re clearly the latter.
In the meantime, I offer this credit score advice for the rest of us — those of us who are focused on results, rather than ideology.
“Um — cool.”
[Fistbump.]
Full Disclosure: This post was created with support from Credit Sesame in partnership with Kasai Media.
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Even if you have no debt (like we do), your credit score matters for insurance. Insurers use your credit score to determine the likelihood of a claim, which affects your rates. So, even if you’re going to buy all of your houses in cash (like we do), you still want to keep a good credit score, which is easy to do if you use one credit card for paying for Internet purchases and then paying the balance off every month! Presto!
See https://www.consumer.ftc.gov/articles/0152-how-credit-scores-affect-price-credit-and-insurance for more.
@Jason — Awesome point! Yep, your credit score influences your insurance premiums — yet another reason I urge people not to abandon their credit scores completely, even if they plan on being debt-free-for-life.
testimonyhackerteam is the only hackers that can do this for you
Credit score matters to me as a landlord – A LOT. It tells me how responsible you are. Without it, you are an unknown.
@Landlord — Heck yeah! Me too. 🙂
I feel sorry for american customers. In Europe Credit card debt and credit scores are virtually non-existing.
A colleague of mine moved to the states for work in a very well payed position. He needed to acquire some debt to be able to get a credit score and be able to get anything done. That is just insane…
Apparently this credit score scheme also helps banks to screw you over. You could get a loan at a much lower interest rate here. as low as 2,2% for a 25 year mortgage. (In Belgium the customers have the upper hand when negotiating for a mortgage, every bank wants to keep/gain customers for life. )
@European Engineer — Your friend didn’t need to acquire debt in order to build his credit score. As I explain in the article, you simply need to open a credit card. You can put a tiny payment on it, like a $8 per month Netflix subscription, and set it to auto-pay in full each month. That alone is enough to start building credit in the U.S.
For recent immigrants, college students and anyone else without an existing credit score, the best cards to open are:
1) secured credit cards, which are bank-issued;
2) student cards; and
3) store cards (only as a last resort).
These cards are often issued to people with no credit, and are great for building a score.
@Afford Anything – Thanks for this info. It was absolutely helpful. I shall do as suggested being a international student.
Wouldn’t being forced to open a line of credit to build credit, be equal to having to go into debt to build credit? I must have missed something?
What about Dunn and Bradstreet scores for businesses? Are these comparable to scores for individuals?
My LLC bought a truck in 2012 and paid it off a year later. The APR was higher because my business didn’t have a D&B credit score yet, but I bit the bullet and paid it to establish a credit score.
@Rebel – That’s a great question; I honestly don’t know enough about D&B scores to really comment on those — I’ve never taken out a business loan or ventured into that world. (For real estate investing purposes, most banks will only issue mortgages to individuals, as opposed to LLCs — especially if you’re buying a residential property, as I do.)
Currently I don’t have any rental properties, but have been seriously considering it.
Interesting about the banks not loaning to LLC’s. I was not aware of this. I’ve heard discussions that rental properties should be placed under separate LLC’s for each structure just in case a tenant sues it only affects a single property and not the entire portfolio and your personal assets. Maybe they meant to assign it after the purchase. I will have to check with my bank about all of this…
@Rebel — For your and my purposes, banks are highly unlikely to loan to an LLC.
There are other large, established LLCs out there — like Chrysler LLC or Kaiser Permanente LLC — that I’m sure could get bank funding. But a brand-new LLC with no credit history and no track record of performance isn’t going to get a bank loan.
Yes, my attorney recommended the same: Put each property into a separate LLC via quit-claim deed. The problem is that many mortgages have a “due on sale” clause, which states that if the ownership is transferred (e.g. from an individual to an LLC), the entire mortgage balance is instantly due. Read your mortgage carefully to make sure you don’t have this clause before you try to execute a quit-claim deed. Some investors have a “due on sale” clause and quit-claim their properties anyway, crossing their fingers that the clause won’t be enforced. But that’s a risk, of course.
Regardless, you should definitely hold a liability insurance policy — that helps protect you in case of a lawsuit.
@Afford Anything
You are incorrect regarding bank lending to LLC’s.
When you borrow from the bank on a non owner occupied residential rental, the loan goes through the commercial lending department. You must put 20% down and from what I’ve found most only lend for up to 20 yrs, more commonly only 15 yrs. Currently rates are around 5%+
If you are investing as an LLC with multiple members then this might be your only option, as this is my current situation.
However, If you are investing as an individual, it’s best to get financing as an individual vs an LLC. As an owner/occupant you can use FHA or conventional and put as low as 3.5% -5% down, but would have to live in it for at least a year before turning it into a rental. Unless your living in 1 unit of a multi-family of 4 units or less. This is the absolutely lowest cost that I’m aware of to get into the Real Estate rental business.
On a side note, you can use a hybrid approach. Own the property personally and finance it with normal 30 yr conventional financing. At the same time Managing it and funneling the income through the LLC to keep it separate from the personal finances.
This method opens you up to personal liability and tax issues, so be sure to discuss this with your tax and legal advisors. Also carry plenty of liability insurance. This is for educational purposes only.
Bottom line is you can finance through an LLC, but it’s not the most desirable situation AND you also will need to personally sign for the financing anyways. The only real reason to do this is, like I said, if you have a partner and you both want to benefit from the capital gains, deductions and Cashflow.
If your partner is a debt partner, this is likely a moot point, as you’re getting financing from a non-institutional lender.
Jeff –
I appreciate your comment, though I’m not incorrect. You and I are sharing the same message: If you are investing as an individual, you’re going to get financing as an individual vs an LLC.
It’s unlikely that a bank would loan to a single-member LLC with zero track record. You would be rejected by several banks, and the rare bank that might accept you would demand a significantly higher risk premium.
I’ve typically seen banks require 30% downpayments, rather than 20%, for investor loans. (Some of the more conservative lenders go up to 40% downpayment demands.) Interest rates are often at least an additional 1% or more higher.
But that’s all a moot point, since a single-member LLC probably won’t qualify for a loan anyway. The lender will demand that the loan be issued in the individual’s name.
Obviously if you’re a multi-member LLC, then there’s no other lending possibility that fairly spreads the risk among its members other than to opt for a loan as the LLC, but that’s not what the reader (Rebel without a Cause) was asking about. Rebel was asking about what financing he/she should get as an individual. And as an individual, he/she is highly unlikely to qualify for a loan from a bank, if he/she applies as a single-member LLC with no history.
This is a very timely article for me as I used to have an 800+ credit score, but did a couple rounds of CC hacking last year (always pay off balance, but didn’t know about the utilization thing, do now!) and now have a score around 760.
All told I think I got about 7 cards of which I’d like to keep three and close 4 to avoid the annual fees. How would this affect my score as it would decrease my limits by quite a bit, but likely bump up the average age of my cards? Is 800 out of my grasp now?!?
Thanks in advance and I like the new site design!
@Sundeep — If you opened all 4 accounts last year, then it won’t have a large impact on “average age,” since all four accounts are approximately one year old. Utilization ratio will drop, but you can work around this by asking your card issuer for a higher limit on the accounts that you keep open (and also by keeping a very low balance on those cards — even going so far as to pay your bill 1-2x per week.)
I do CC travel hacking myself, but a “lite” version (I open about 1-2 cards per year, and I don’t open any cards within 6 months of a mortgage application). By keeping it light, I’ve been able to keep my score between 805 – 820.
Thank you for the compliment on the new site design!! 🙂
Option B! It’s always Option B))
I love reading your blog and have learned a lot from it. Credit can be confusing to me and this helped a bit about understanding how they calculate score. I have a few negative marks on my record as I had to short sell my house 2 years ago after I lost my job and struggled finding a new one. I’ve been working on getting out of debt and have made great headway and my score is now above 700. Is there a blog that you’ve written on removing those negative marks or do you have some suggestions as to fixing that? Thanks in advance.
@Chris – Thank you for the compliment! High-five!
There’s no way to remove a negative mark (if it’s accurate/legitimate). Your best tool is the passage of time. It’s already a 2-year-old mark, which is great (that’s far better than a blemish that happened in the past 6-12 months). The more time that passes, the more your score will improve. In the meantime, focus on keeping your current score as high as possible via low utilization ratio / on-time payments / keeping old accounts open.
One more thing: If you’re filling out a rental application (home/apartment), talk to your landlord in advance about the short sale — especially if he/she is a “mom and pop” landlord rather than a gigantic company. Many landlords will be understanding about a negative mark that arose from a short sale or a foreclosure, if the rest of your credit report (credit card payments, etc.) looks great. Personally, I never hold short sales / foreclosures against my tenant applicants … it’s late payments on other bills that give me pause.
Thank you so much! I’ll be sure to do that as I’m starting the hunt for a new place to live!
We pay off our credit card balance every two weeks to maintain a zero balance. Around the holiday time we take our reward dollars to Amazon for a few small gifts. Lots of people so cut them up but I wont.
@Pete — I love CC rewards for exactly this reason! I fly overseas for free between 1-2x per year.
So once you get a debt collection on your account that you’ve already payed in the past, is there anything else you can do to get it off of your report?
@Mike — Before you pay off the debt, call the collector and negotiate to have it removed from your credit report. Ask them to agree to this in writing. (I’m saying this for the benefit of other readers who are in your shoes).
In your specific case, since the debt is already repaid, your most effective tool is the passage of time: The longer in history that the negative mark happened, the better. In the meantime, focus on keeping your current activity healthy through on-time payments / low utilization ratio / keeping old accounts open.
Nice comprehensive post. Great point on focusing on the big factors to keep your credit score high.
I used to follow your strategy of paying off CC bills early, but I like having that “float” in my checking account and I don’t get anywhere close to having a 10% utilization.
The credit score doesn’t matter nearly as much as the actual information in your credit report. When I was applying for loans for my most recent investment property (my third property including my home), my score was in the mid-600’s. I had one late payment, which hurt me dearly (and still does), but the lenders actually looked at my credit. I’ve never had a late payment on an installment loan, and only that one blip on a credit card a few years prior. I had two mortgages, one cashflowing. They gave me a loan for a little over $100k for 4.875%. Not great, but it’s cashflowing $400/month.
Just after I closed that deal, my Fiancee was buying her first home. She had a stellar credit score (well over 800), but virtually no credit history. She had a lot of trouble finding a lender that would deal with her.
History matters, not score.
@Colin — It’s not an “either/or” equation. Both your history AND your score matter. Nurture them both.
Excellent advice. I jumped on the Dave Ramsey bandwagon in my early 20’s and cut up the credit cards. Ended up having to start over. Mint.com also provides a free credit score every 3 months if anyone is interested. Great addition to the site.
Interesting thing about MINT. The credit score you get from them is not necessairly being reported by the big 3 reporting companies. In buying our house I carry no debt but had no credit for the lenders to see. My MINT score while stating it was from Experian did not show up on my credit report. Anotherwards, it may have been accurate but it didn’t replace the score on an actual credit application.
Is it still better to keep a credit card open even thought it charges a yearly fee and offers no rewards?
@Jackie — If it charges a yearly fee (with no rewards), I’d lean towards getting rid of it, unless it’s REALLY old. For example: If most of your cards are 2-years-old or 3-year-old, that that’s your one-and-only 12-year-old account, for example, I would keep it. But if the card is only a couple of years old, I’d get rid of it.
Hey Paula,
Just wanted to point out quickly that Credit Sesame (and Credit.com) pulls their score from Experian. If you have an account there and one also at creditkarma, you can get your estimated score from all three agencies. Experian missed the oldest account that I had, which caused my score to drop 60 points (due to mix of account age being very low) – I reached out to the company in charge of the account to have them report to Experian, so we’ll see how it goes!
You make a (well, actually you make a lot of them!) great and little known point about paying your credit card early. The balance that’s reported to credit bureaus, and so ends up feeding that fancy credit score calculating machine, is the account’s balance on the last day of the billing cycle. So even if you pay off the balance in full on the due date a couple of weeks later, your credit utilization ratio could be high! As you suggest, pay off the balance before the end of the statement cycle to lower credit utilization.
I think everyone would want to have good credit. Just for the sake of having good credit, and being able to have a mortgage that has a reasonable interest rate.
When I was fresh out of college and trying to buy a house with no credit history, I read a book they taught me a pretty cool credit hacking trick that I figured I’d pass on. Basically, you just need to have someone (likely a parent) who has really good credit and trusts you a little bit. For me, that person was my father. He had a near perfect credit score smooth multiple credit cards that he paid off in full every month.
Here comes the hack … I asked him to make me an authorized user on one of his credit cards. It took a single phone call on his part, the credit card company added me, and when the card came in the mail I simply cut it up.
The result? His entire credit history on that card was now being factored into my credit history!!! Awesome!!! I was a 22 year old with a 20 year history of on-time payments on my credit report. Ten years later and I still have it on my credit report, and I’ve never even had that credit card in my wallet.
Figured I’d pass on the tip … research it for yourself if you don’t believe me!
@Aaron — Excellent point! Getting added to someone’s account as an authorized user is a great way to hack your score. Thanks for sharing that tip!
There’s one caution that I’d issue to anyone else who’s reading this comment thread: If the other person (the primary account holder) harms their own credit (e.g. pays late), you’ll also get hurt. In other words, it’s a two-way street: the primary account holder’s actions can both help and hurt you. If you’re going to get added to someone else’s account, be 110% confident that the primary user is a rockstar at managing his or her credit. If they are …. sweet!!
Great point! I hope my dad doesn’t go belly up!
exactly what my folks did for me, along with setting up IRAs in my name as well.
In Asia, there is no such thing as credit scores. Banks and other financial institutions consider giving out loans to people who are debt-free, or had no debt history. Being debt-free is a proof that the individual is financially responsible and that they can manage and budget their own finances.
I think that managing your money in an effective way is very important in life. I see a lot of friends who spend their money as soon as they get it. Thanks affordanything for this article. It was very interesting.
Is it true that getting married can hurt one’s credit? I’ve worked so hard for my credit score and been responsible. I don’t think I want to get married if it does! lol
Hi, Sarah,
Your credit score isn’t affected by your future spouses credit UNLESS you sign for something jointly and then don’t pay THAT bill on time (late payments on a car or house). There are two things that come to mind; one pragmatic and one more philosphical.
First, if you are planning on marrying to someone who does not share your views on money/frugality/responsibility/etc. it is CRITICAL that you have in-depth conversations and pre-marriage counseling on getting on the same page. Money fights and money problems are the #1 cause for divorce in America, the symptoms of which can show up in other areas of your life (substance abuse, verbal/physical abuse, infidelity, etc.). If you are with someone who you fear combining finances with PUMP YOUR BRAKES ON GETTING MARRIED. You’re not ready to share a life if you’re not willing to share your money/financial position.
Second, if you do get married and it doesn’t work out, make sure to get your name off of anything your ex will take possession/control of. I went through a divorce about 4 years ago. My ex and I signed on a car. She took the car and I just assumed she would pay on time. Didn’t happen and it wrecked my credit score. Also, the creditor wouldn’t let me off the note. Just be careful.
All great tips, Paula. And your inimitable style of writing is always a pleasure to read.
One thing, and you can call it nitpicking, that I have to mention on this: Here’s the catch: This ratio is measured by the amount you charge, even if you pay your bill in full every month.
That’s not entirely correct.
Credit card issuers report the outstanding balance on your account, usually the balance due on the monthly statement, to the credit bureaus. As Kurt, in a previous comment referred to. So, if you don’t pay down your purchases every day/week, then yes; the utilization ratio will be based on the total amount you’ve charged to that card, for that period. But if you do pay down your balance within the billing cycle, the utilization ratio will be based on the outstanding amount on that card, for that period.
Yes, exactly. That’s precisely why I recommend paying the balance daily/weekly/biweekly, so that the balance reported to the credit bureaus is a lower amount. I think we’re both saying the same thing. 🙂
@ Paula Pant – But how does it matter if i paid biweekly or at the end of the month in full?
As mentioned by krishanu the utilization ratio will be based on the outstanding amount on that card, for that period. So essentially if i paid all the outstanding amount of the billing cycle at the end of the month. Will utilization ratio will still be low?
Thanks for this post. I used to follow your blog a while back and was surprised to see your new look. I too am on the path to the same lifestyle you have now. Travel, real estate, investor, etc…
What I did like in this post was the point you made about how much credit you charge, not how much you “carry”. Where did you find that information (because I have been reading over and over all over on many different sites to learn how to improve my credit score)?
It is certainly a game but a game that opens doors, and I need some doors to open to get where I am going. I look forward to coming back to read more of your posts.
Excellent article, Paula, thank you. That cleared a few things up for me.
I’ve got Excellent credit on the low end, which I think was built up from having just one credit card that I got 5 years ago, and no late payments.
I’ve been considering applying for a credit card with better rewards, but don’t want to hurt the average length of time my accounts have been open. Do you have thoughts on how long a line of credit should be open so that it doesn’t negatively affect your score? I’ll probably want to buy property in the next 5 years but don’t want to make my credit score worse before that time.
Hey Paula,
Thanks for another very helpful article! You are my go to for finance articles, can’t wait for your podcast! :]
Just curious, if I’m offered to increase my credit limit but I have a balance I’m trying to work down on it, should I do it? I know since I’m offered the increase it doesn’t hurt my score and I’m trying to improve my credit utilization by having more credit available, but I do have about $3k on my balance I’m whittling down on. I have stopped using credit cards until I’m done paying it off (should only be another month or two) so I know I won’t just run up the bill. But is this something smart I should do? Or am I better off just leaving my credit limit where it is? I have two cards (the other doesn’t have a balance) but this one is using just under 50% of my credit limit. Any advice on how to continue please?
Hi Samantha,
Thank you for the compliment!
If I were in your shoes, I’d increase my credit limit for the sake of improving my utilization ratio. (Assuming that a higher limit won’t result in higher spending, of course!) Since this is already an open line of credit, you won’t be establishing a new account, so it won’t harm your average account age. There WILL be a credit inquiry, but the effect of that will fade after a few months.
Cheers,
Paula
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Hi!
I just recently got my first credit card because I wanted to start building credit. I live with my parent (do not really have any bills), but what ever I put on my card I have to and plan to pay it in full right away, so I will never have a balance carry over. I am having trouble understanding this part of the article,
“Myth: If you pay your bill in full every month, you don’t need to worry about “amounts owed.”
Fact: Wrong-o. Your utilization ratio is based on the statement balance reported to the credit bureaus monthly — regardless of whether or not you carry that balance over to the next month. In other words, even if you pay in full, you could still have a damaging utilization ratio (“amounts owed.”)”
Earlier in the article you put a link to another article that stated it was a good thing to pay in full and not carry a balance. So with this myth/fact is it saying that even if I never carry over a balance it could still do damage to my score? I do not really understand it. How would not having a balance to carry over damage my utilization ratio?
Sorry for my confusion. Thank you thank you in advance for your help! I REALLY appreciate it!!
So… Great pod. Awesome blog! Thanks for both!
I have a few CC. I have maxxed each out and paid them of as soon as the charge cleared after making a run to Seattle for the RHCP concert with the family. And then other stuff.
Assuming I pay in full before statement and reporting day and hold a zero or small (1-10%) balance at that time my utilization should be good, right?
I just want to say that i refer to this article every once in awhile and it’s always a great refresher. thanks!!
Nice article, Paula!
It inspired me to look into calling up my credit card companies to see if they can increase the limits without any hard pulls so I can lower the debt utilization ratio to boost credit score.
Will keep you posted on how it goes 🙂
-Jack