The Most Misunderstood Credit Score Factor

Despite your best intentions, there may be times when you just have to carry a balance on your credit cards. When you do, how do you protect your credit score? Reader Eddie Vidmar writes:

At some point within the next few months, I am going to have a rather steep expense of putting in some fencing. That is going to cost me to the point where I may run up my credit cards. I will assume that by using a high percentage of my credit, as I spend 90 days zeroing all the cards out again, I will see a slight dip in my credit score. Does logic say that after that 90 days when I zero them all out I should see it go right back to where it was, or does a brief period of “He used 60% of his credit” have an effect that lasts longer that “He is now back to 0% of credit used”?

He went on to explain that he plans to use about $1,000 of his $3,000 in available credit. That will put him right at about the 30% range for “debt usage” (also known as “utilization.”) FICO says that consumers with the best credit scores tend to use less than 10% of their available credit. While there’s no specific percentage you must stay below to have excellent credit, it is best to try to keep balances below 20% to 25% of your credit limits if possible. Higher than that, and your credit scores may suffer.

Planning Ahead

Vidmar’s been working on his credit scores and over the past year he’s increased them by roughly 100 points. He monitors his credit scores and tries to avoid carrying a balance. “I generally keep my credit usage to 10-12% and pay the bills down to 0% every month,” he wrote in an email. So he’s smart to plan ahead for what may happen.

The good news for anyone in this situation is that high utilization can be a temporary problem. Unlike your payment history, which takes into account every late payment on your credit report — past or present — this factor is based on current information. In other words, whatever the balance and credit limits are at the time the your credit report information is requested, that’s what will be used to calculate the debt usage ratio.

(That may change, though. Some credit reports are starting to report cardholder’s previous balances and how much they paid in comparison to their credit limits in the past, but that information is not widely used in credit scoring models today.)

Minimizing Credit Damage

If debt usage is bringing down your credit scores (you can find out by getting a free credit scores and a free credit report summary from Credit.com), you have a few options:

Pay down balances. As soon as balances on your credit reports are updated (most credit card issuers provide updates monthly to the credit reporting agencies), that new information will be used to calculate scores. Paying down debt can help remedy this factor.
Use a personal loan to consolidate high credit card balances. This tactic may help raise your credit scores since personal loans are reported as “installment” loans on credit reports, and the debt usage ratio is not a factor for those loans the way it is for credit cards (which are considered “revolving” accounts).
Spread out balances. It may be possible to avoid high utilization by either splitting up charges among different cards or by transferring part of the balance to another card with a low balance and/or more available credit.
Get help. If you’ve been struggling to pay down credit card debt and your cards are maxed out, it’s not a bad idea to talk with a reputable credit counseling agency to see if they can help you put together a plan to get out of debt.

Wanting to make sure he’s on the right track to rebuild his credit, Vidmar asked another question related to debt usage, “Some offer the theory that taking a small, manageable balance forward every month actually helps your score. I tend to think that it does not help your score.” He’s correct. It’s not necessary to carry a balance to build or maintain strong credit.

Debt usage is often in flux, because balances tend to change from month to month. Reviewing your limits and balances before you make a large purchase, as well as paying attention to your credit rating, can help you decide the best strategy going forward.