What's in *your* wallet?
OK, so I don't normally mix business in with my blog, but I think this tip might be worth passing on.
I work in the mortgage industry, and I do a lot of credit-counseling for people that have had some credit missteps in the past. I have found that most people have no idea how credit scores are calculated, what the range of good to bad scores is, how to keep a good score high, or how to bring a bad score up. So, a lot of what I do is simply educating people so that they can understand how the credit score machine works, enabling them to make better credit decisions and, hopefully, to save them money on their mortgage payment in the long run.
Everybody knows that paying your bills on time will help a credit score, and paying them late will hurt it. That is definitely true, and this accounts for 35% of the total score, the biggest chunk of any of the factors.
What fewer people know, however, is that the second biggest factor, accounting for 30% of a credit score, is the ratio of account balances to credit limits, both for individual accounts and for all accounts together. A balance close to or over the limit on any one account can drop a credit score significantly because a maxed out card is a pretty good indicator that a borrower may be facing some financial challenges. Keeping a balance below 20% is best, 50% is OK. Having a balance above 70% on even one account can really damage a score.
Another easy way to tear down your credit score is to have a Capital One card. No, I'm serious, and here's why. Capital One never reports credit limits on accounts, only balances. I've heard conspiracy theories about why, including that they are in cahoots with banks and they benefit by people having lower credit scores and higher interest rates on mortgages. At any rate, I've never seen a Capital One account with a credit limit listed. See this example below:
The High Limit is "unknown," but the High Balance is listed. Even if the high balance were $5, simple mathematics tell us that the ratio of the balance ($5) to the limit ($0) is infinity. Having a balance-to-limit ratio of infinity is a bad thing. Even if you pay the card off on time each month, even if you've never missed a payment, and even if you have a credit limit of $10,000 and a balance of $10, the simple act of having a Capital One card can lower your credit score significantly.
So, the next time you see those Viking maurauders crashing through a window or tearing up some guy's lawn, remember that's similar to what their credit card will do to your credit score.
I would be happy to answer any other credit-related questions that anyone might have. I have some pretty good educational resources I've put together that are only a page or two long that I'd be happy to e-mail to anyone that's interested. Just let me know.
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Here are two questions:
So should we request our credit-card companies to raise our limits — not because we're going to charge more, but to reduce the ratio of account balance to the limit?
Also, what if you pay off a balance before the closing date. Here's what I mean: I charge my children's tuition, which I pay once a year. So it's a big charge. (I charge it to get the miles, paying cash is not a problem.)
But that's a hefty charge with two kids in a private school, so charging their tuition puts me over the 20% ratio — close to a 50% ratio for that month. So I don't want to do that if a "bad" ratio counts against me, even if I pay it off that month (which I do).
But what about this: I charge the tuition on the card, then pay it off before the closing date for the month, so the amount owed on the closing date for that month remains zero.
Does that avoid the problem? Or does my credit score go down if there is any point during the month at which the balance owed on the card throws the ratio out of whack?
If you have the cash, I would say that you should charge it and mail the payment on the same or next day. The high balance will probably not be what is reported, since it will only have that balance from the time the
transaction occurs to the time you pay it back down. The only way that would happen would be if the charge occurs, they send off the data, and then they receive payment after that. So, your solution to charge it and then pay it off before the monthly cycle closes is a good one, especially if you know the monthly close date.
It also sounds like this is a once-a-year thing. If so, then I wouldn't worry too much about it. A credit report is like a point-in-time snapshot. If this whole cycle happens every August, for example, then even if you wait to get your statement before paying, the reported balance will be back down by September or October.
It also would be a good idea to routinely ask for higher limits. The "ideal mix" of credit, from what I've read, is to have 2-3 credit cards with high limits and low balances, a car loan, and a mortgage. This isn't necessarily the best "financial" position to be in (i.e. having a paid off house is great), but it gives potential creditors a very good track record to look back on to see that you're experienced with credit and you've been successful in managing your debts in the past.