The Less Often You Borrow, The Better
The most important thing to realize and take into account is that credit scores only measure one thing, the risk of a given person defaulting on a credit facility. The credit facility in question is always the next one by the way, that’s what these scores do, they look to predict the likelihood that they will default on the credit product that comes next, the one under consideration when one checks your credit scores.
This might not seem to be all that meaningful at first glance, and people might say, well of course that’s what credit scores measure, but really understanding this concept is the key to the whole deal here, and when questions come up as to the effect of certain actions on one’s credit score, if we keep this concept at the forefront of our mind, we’ll at least be on the right track.
There’s actually more to this than just looking at one’s current credit situation, and what they are really after is looking to predict the future, which only makes sense since all potential defaults on credit products applied for will occur in the future.
This is more than just looking toward the past, although past credit history does play a huge role in this. It’s also looking at where one’s credit using may be trending, and where it may trend based upon past usage.
A lot of people think that credit scores just look at borrowing and paying back and that’s really all it’s about, borrow and pay back on time and you’ll be fine.
Ideally though, to get the really top credit scores, ones higher than required by anything by the way, one could borrow but would not borrow at all, strangely enough. This might not be practical of course but it does serve to illustrate how this all works.
All borrowing represents a risk, not so much the risk of the past borrowing, but the propensity to borrow. If someone had a credit card for the lookback period of the credit bureau report, 6 years or whatever the bureau uses, and never used it, and only had one credit product, a credit card we’ll say, that’s perfect actually.
This may not make sense to a lot of people but it does make perfect sense in terms of risk assessment. We need to ask ourselves, what’s a big worry of a credit grantor? It’s that the borrower will borrow more and get themselves in trouble down the road. The less you borrow, the less risk you represent.
Our person here really doesn’t borrow much, so when he borrows now, adds another product, we can be more comfortable with this person not overextending themselves during the life of the credit product we’re looking to grant.
Of course, this only applies to those with active credit facilities, in our case a credit card that wasn’t being used, but kept active. If someone had no access to credit then not borrowing isn’t going to help, in contrast to our case where the person did have access to credit but used it with the utmost of restraint.
The bottom line here is that less is more when it comes to borrowing, and if you’re interested in maximizing your credit score, you should show as much restraint as you can in borrowing.
Available Credit Used Really Matters
Another myth concerns the way that the amount of available credit you have influences your credit score. Many people are familiar with the notion that you aren’t supposed to go over a certain percentage of available credit, 50% or whatever, but they usually don’t understand the implications of this.
For instance, they may be considering an increase in their credit limit and somehow may think that this will negatively impact their score, or they may reduce their available credit, thinking that this will help them. Nothing could be further from the truth though.
Percentage of credit used is heavily relied upon in credit scoring, and it’s not just a matter of going over a certain percentage of available credit, even though higher amounts have greater negative impacts upon your score, the over 50% for instance that people throw around.
Ideally, usage of available credit would be zero, at least in terms of what is reported, and from there, using credit with revolving products like credit cards have a greater and greater negative impact upon your score, and all of this is based upon the probability of default.
The difference between 0 and 10% isn’t going to mean that much more risk of default, but as the numbers get bigger, the risk increases, and being over the maximum is of course the worst. So it pays to try to keep this down, and it also pays, interestingly enough, to increase your overall credit limit.
One of the best things to help your credit score for instance is to go from a high percentage usage to a low one through a debt consolidation loan, and this can have a dramatic effect upon your score even though you owe the same amount, and you may even owe more if you added more than the revolving debt to the loan.
This may seem odd until you realize that your risk of default has just gone down, by a lot actually, because you have all this available credit to fall back on if needed, where before you were much closer to the line and therefore considerably more likely to go over it, statistically speaking anyway.
Paying Them Off Often Doesn’t Even Help
A lot of people will tell you that they are just fine because they pay off their credit cards every month. Your score doesn’t take this into account at all though, and in fact a lot of people hurt themselves by having too small credit limits and seeing their balances represent a large portion of utilized credit prior to paying the entire balance, depending on the timing of the payments
When the credit card companies render your monthly bill, this is the time that they also report the balance to the credit bureaus. For instance, if your credit limit on a card is $2000, and you put around $1500 a month on it, get the bill, and pay it off in full, you’re crapping out on this.
When the credit bureaus get these reports, all they see in fact is 75% credit utilization, and this puts you in the same boat as the people who rack up their balances this much and don’t pay it off, and many may just be squeaking by and just making minimum payments, and may just be one piece of bad luck away from default.
Sure, you paid it off, but after the report, so it happened completely in the dark. Then, you make your monthly $1500 worth of purchases and the whole thing happens again, another month of high utilization.
The key here is to make your payment before the bill is rendered, so that your bill is as small as possible, preferably zero. That’s not realistic if you’re planning on using the card for all your purchases to gain the rewards, but you really don’t want to wait until the billing period is over to make a lump sum monthly payment either, if you’re looking to improve your credit score that is.
Some Further Credit Score Tips
So paying more frequently works here, but it’s perfectly fine to just make a single monthly payment, provided that there is enough time between the payment and the due date for the payment to be processed prior to that.
You might not care about any of this though provided you have no plans to apply for credit anytime soon, but there’s no reason not to make your payments credit score friendly if you are at all able to do so.
Accepting that credit line increase that credit card companies often offer you, or even proactively applying for one yourself, is a good idea as well, credit score wise, although you don’t want to set yourself up for failure either by getting too tempted and then getting yourself in more trouble than you would have if you would have not increased your borrowing capacity.
There are other things that go into credit score calculations, not paying anything more than 30 days after it is due is a huge one for instance, and this is to be avoided at all costs actually, as this causes long term damage to your score.
Not applying for new credit products when you don’t need to is another big consideration, and if you do need to borrow, by all means apply, but given that too much credit seeking is indeed a risk, too much of this can lower your score. People tend to overestimate this though and think that all credit inquiries are bad, but as long as one only requests a reasonable amount, it won’t have much impact.
Being aware of how credit cards affect your credit score can be plenty useful though, not so much as far as getting more credit cards, but in applying for other products.