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I’ve never paid a bill late. That’s not so much a boast as an admission of a possible mental disorder. Still, my compulsive habits did get my credit score up to 815.
Then, when my wife and I opened a new bank account six months ago, the banker told me, “Your credit score is 764, which is great.” Great? That was a 51-point drop! My wife’s score was higher than mine for the first time!
I was surprised by the extent of the drop, but I had no plans to borrow money, so it was largely irrelevant. In fact, I was happy about the change, because I understood why it happened and so I learned a powerful way to control my credit score.
Today I checked my score. It’s 809 — a 45-point increase in six months. Why the big drop and big rise? It’s all about the “games” I was playing, and how they affected my credit utilization ratio. The following explanation will clue you in to how to boost your own credit score.
The Big Drop
I had been applying for many new credit cards to earn signup bonuses. Opening new accounts can lower your credit score, but it knocked me down just a few points each time, and those drops were followed by a quick rebound (you’ll understand why in a moment).
Then, in addition to amassing a pile of credit cards and using them to earn cash back and other rewards, I decided to do a little credit card arbitrage. Some of my cards offered 0% interest for a year or longer, so I ran up the balances and, rather than pay them off every month as I normally do, I put the money to work.
For example, I charged over $6,000 to my SunTrust Mastercard, mostly grocery store purchases that earned 5.5% cash back.
The 0% interest offer ran for another year at that point, so rather than pay the balance I put the money in a Brinks 5% savings account and made just the minimum required payments. I collected about $210 in interest before paying off card with the money from the savings account.
I did this with other cards, and my score started really falling. Why? Because I owed a lot relative to my credit lines. To put it in credit-card-speak; I had a high credit utilization ratio.
Let’s get back to that in a moment, and first do a quick primer on…
What Affects Your Credit Score
According to Cafe Credit, there are the five crucial factors used by FICO (the primary credit score creator) to determine your score. Here is the relative weight of each by percentage:
- Your payment history: 35%
- Your credit utilization: 30%
- The length of your credit history: 15%
- Your new credit: 10%
- Your credit mix: 10%
The first factor is obvious, and if you haven’t always paid bills on time, starting now will help your score. But it takes time; late payments stay on your report for seven years.
Factor 3 (we’ll get back to 2) has to do with how long each account has been open. Longer is better, so you can avoid damage to your score by not closing old accounts. But to boost your score all you can do is wait.
New credit is looked at to see if you’re opening too many accounts too quickly, as I was doing. This factor is only about 10% of your score, and any damage done goes away with time (and with the resulting better credit utilization ratio, as we’ll see). US News has a list of criteria that you should look into before you apply.
“Credit mix” refers to the types of credit you’ve utilized, and variety is considered better. If credit cards are the only thing on your credit report your score might rise once you borrow for a car or home (and make the payments on time). Of course borrowing to improve a factor that represents only 10% of your score doesn’t make any sense.
So that leaves us with the most important factor that you can affect quickly…
Your Credit Utilization Ratio
Divide what you owe on a credit card by its limit, and you have your credit utilization ratio for that card. It’s expressed as a percentage. So if you owe $1,200 on a card with a $5,000 credit limit, your ratio is 24% (0.24). Divide the sum of all your balances by the sum of all your credit limits to get your overall ratio.
Research done by Credit Karma suggests a simple rule: The lower your credit utilization ratio, the higher your credit score. There’s an interesting exception, and that’s if you have a utilization ratio of 0%. In that case you should start using your credit cards to raise your score.
Now you can see why my score rebounded every time it got nicked by new account openings. The new cards increased my total available credit, and since I paid balances in full every month, my total debt relative to my available credit had dropped.
Consider a simplified example: If a new credit card brings the total of your limits up from $5,000 to $10,000, and you still owe the same $1,000, your ratio drops from 20% to 10% immediately (or at least as soon as the new card shows up on your credit report).
It also makes sense why my score dropped so precipitously once I started playing around with credit card arbitrage and kept high balances on my cards. My overall credit utilization ratio went from something like 2% to 20%, and on individual cards it reached 90%.
Then, when I paid off those balances, my ratio returned to a much lower level. Once this new information made it onto my credit report my score jumped 45 points in a couple months.
How can you put this information to good use? For starters, don’t play around with credit card arbitrage if you’re going to be getting a mortgage, or need to keep your score high for other purposes. And, if you want to further boost that score, use these…
10 Ways to Lower Your Credit Utilization Score
According to Bankrate, NerdWallet, and my own experience, here are some of the things you can do to lower your credit utilization ratio and therefore raise your credit score. We start with the fastest and most powerful (and perhaps dangerous) strategy…
1. Open More Credit Card Accounts
The concept is simple: Having more credit cards increases your total credit available, and so lowers your utilization ratio.
Suppose you have two cards with limits of $2,000 and $3,000 and typically have a total balance $1,200. Your credit utilization ratio is 24% ($1,200 divided by the $5,000 total) Now suppose you get six new credit cards and your limits add up to $30,000? That typical balance of $1,200 is just 4% of your available credit. You’ve drastically reduced your ratio.
Can having too many accounts hurt your score? That’s difficult to answer because scoring models aren’t entirely transparent. My own score is 809 and I have 25 credit cards. A Bankrate article gives the example of a man who has 80 credit cards and a score over 800.
FICO doesn’t mention any effect from the number of accounts, only from the number of new accounts.
Of course having a pile of easy-to-use (and abuse) credit cards is only a good idea if you’re sure you can handle the temptations and management involved. If you are worried about having too many accounts, another way to increase your total credit available is to…
2. Get Your Limits Increased
My cards have limits ranging from $500 to $25,000. My guess is that if one issuer is willing to extend $25,000 unsecured, that $500 card issuer would probably raise the limit if I asked. You could probably get your limits raised on some of your cards too.
Higher limits equal a lower ratio as long as you owe the same amount. For example, with a few phone calls requesting an increase the sum of your limits might go from $10,000 to $15,000. If your balances total $3,000 your ratio would drop from 30% to 20%.
Note: A credit line increase might require a “hard inquiry” or “hard pull” on your credit report, and too many of those can knock down the score. That should be temporary, but if it’s a concern you can also limit your requests to credit card issuers who do soft pulls for limit increases.
3. Buy Less
The less you owe on your credit cards, the lower your ratio. Therefore being more frugal helps. Obvious? Yes, but I didn’t want to leave anything out.
4. Use Cash More Often
Less obvious is the fact that charging less may help even if you always pay your cards in full every month. That’s because the balances may be used to calculate your score prior to your payment.
So using cash more often can help. You can set a limit of 20% utilization, for example, and when you reach that you can move to using cash until you’ve paid off the card balances.
5. Time Your Payments
Credit card companies report to credit bureaus each month, and your balance on the reporting date is what counts. If you pay off your balance a day before that it will be reported as $0. To do this you need to know the reporting date for each card, which you can get by calling.
One my credit card issuers tells me they report information on the 2nd of every month. Typically I pay that card in full toward the end of each month, and haven’t had time to charge much on it by the 2nd of the next month, so my reported ratio is naturally low.
On the other hand, if I made my payment on the 3rd of the month, the balance reported would be near it’s highest point. The card would show a higher credit utilization ratio, as would my overall credit profile. Clearly when you pay can make a big difference.
What if you find it’s too much trouble to time the payments on six different credit cards? Try the next strategy.
6. Make Two Payments Monthly
If you pay something on your credit card twice each month the balance will be lower whenever it’s reported to the credit bureaus. For one of the payments you can use the automatic “bill pay” feature of your checking account, so you’ll just have one other to deal with manually.
7. Track and Balance Your Card Usage
Since a high ratio affects your score even if it’s just on one card, it makes sense to spread your charges among cards. You might set a limit of, say, 20% per card. In that case, if one card has a limit of $2,000, you would stop using it once you’ve put $400 on it, and start using another card.
If unexpected expenses come up after you’ve spent 20% of your total credit available, don’t start charging everything to one card. Just move your self-imposed limit to 30% if necessary, but spread the purchases out so no one card exceeds that.
8. Use Those Alerts
Most credit cards have a system of alerts you can set up online. One of the usual options is to receive an email or text alert if your balance reaches a certain amount. So, for example, if you have a limit of $5,000 on card, and you want to keep your ratio to a maximum of 20%, you can set it up so you get an alert when your balance reaches $1,000.
When you get an alert you can choose to pay cash, use another card, or wait until you pay down the balance to make further purchases.
9. Keep Accounts Open
Older accounts are good for your credit score, so don’t close those unless they have an annual fee. But even newer accounts that you don’t use contribute to your total credit available, and so help keep your utilization ratio lower.
If you have a problem with handling credit you can leave the account open but cut up the card so you won’t be tempted to use it. Be aware, though, that after a year or two of inactivity the account may be closed by the issuer.
10. Use Your Cards
After a year or more of inactivity some credit card issuers will close an account without notification. With 25 cards, this is a problem for me. My solution is to use a card, mark the calendar to use it eleven months later, and then put it away with my other inactive cards.
I started this policy after having one of my best cards (old account, $10,000 limit) canceled by the bank because of a year of inactivity.
Use those cards once in awhile to keep your account open. They all contribute to your available credit, and therefore keep your credit utilization ratio lower. That, in turn, keeps your credit score higher.
How much can you increase your credit score by working on that ratio? That depends on your particular credit profile. I was able to rebound 45 points in a few months, and by lowering her credit utilization ratio, Kiplinger writer Stacy Rapacon says she saw her credit score go up by more than 50 points in under six months.
Have you seen big changes in your credit score due to credit utilization? Tell us about it below.