Credit Card Balances And Your Credit Score

Understanding how credit card balances affect your fico score can be somewhat difficult to comprehend

. There are certainly many misconceptions and much misinformation that are circulated among consumers, mostly coming from friends and family that mean well, but don't really understand how credit scoring works.

One of the most misunderstood pieces of the fico scoring puzzle is how credit card balances affect the credit score. The bureaus typically add and subtract points based on the total balance relative to their respective credit limits. In other words, the percentage of the credit limit used is often more important than the actual amount owed on the account. The credit bureaus tend to add or subtract points based on a tiered scale that changes whenever the balance goes over or under 25% incriments. So having a credit card with a balance over 25%, 50%, 75% or 100% of the limit will trigger changes in the credit score.

As an example, let's assume you have a charge card with a balance of $600 and a limit of $1000. The balance is 60% of the credit limit. Since that's over 50%, it will tend to lower your score. Suppose you pay $200 on the account, dropping it to below 50% of the credit limit. This would raise your score, and probably quite a bit in most situations (credit scoring models take many different factors into account, and the amount of the increase will depend on other factors). However, if you piad $400 on this account, the credit limit would drop to below 25% of the credit limit, which would raise the score even more than just paying it down to 40% since you've dropped it below another one of the 25% benchmarks.

On the other hand, if you ran up the balance to $800, that would tend to lower your score even more since you pushed the balance above the 75% mark. And if you maxed out the card to over the limit? That could cause your credit score to drop substantially.

So the bottom line is that you need to make an effort to target the balance where it's under 75%, 50% or 25% of the credit limit. The lower, the better.

HERE'S ONE IMPORTANT THING TO REMEMBER! Don't assume that paying off your credit cards every month will mean the credit bureaus calculate your score with a zero balance. Credit card companies only report to the credit bureaus once a month, and this tends to be at times when the balance is at or near the high point of the month (close to or on the day the billing cycle ends). So if you happen to run the balance of your credit cards over 50% of their limits in any given month, there's a good chance that balance will be the one that is shown in your credit file. So it's a good idea to ALWAYS try to keep the balance at or below 50% of the credit limit, even if you plan to pay down the balance when the bill comes. Quite simply, you have no control over when your credit card company will report the balance to the credit bureaus.

Credit card balances are just one of the many factors that determine your credit score. The most important factor is your payment history, so don't ever miss a payment on an account in order to pay a large payment on another account in hopes that this will raise your score. The damage caused by the late payment can be far greater than any improvement you will see from paying down a credit card.

Copyright (c) 2010 John Gough Rasor

by: John Gough Rasor

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