Thursday 27 Sep 2012

Beginner’s Step’s #1. Your Credit Score v.2 – “Credit Utilization Ratio & Myth’s about Credit”

This is the 2nd post about Your Credit Score in the Beginner’s Steps series. Let’s have a short recap about what was discussed in the previous post about Your Credit Score:
- We learned what a CRA is – Credit Reporting Agency, who they are, and knowing the importance of what card issuers pull your credit from which agency.
- We learned the importance of checking your credit report & score.
- We learned where to check your credit report & score DAILY for FREE!

At the end of the last post I made a comment saying “I pay off my credit cards in full every month, so the score will shoot back up next month. “.  This is a true statement, so let’s talk about your Credit Utilization Ratio.

“What the heck is that, and why does it matter?”

Your credit utilization ratio is the percentage of what your monthly spending on credit is to your available credit. For example, if you only have 1 credit card, and it has a $1,000 credit limit, and your credit card statement posts that you spent $800 that month, you are using 80% of your available credit. THAT IS TOO HIGH AND WILL AFFECT YOU NEGATIVELY!
I know most of you that have credit cards have more than one, and your limits are much higher than $1,000, but that was just an easy example.
Aside from on time payments, your credit utilization ratio is one of the most important factors in your credit score. The cool thing about your credit utilization ratio is that it fluctuates monthly, or even more frequently depending on when your different credit card bills post in the month.
Ideal credit utilization ratio = Using 2-20% of your available credit.

If you’re not using your credit at all, your score suffers that month, and if you’re using over 20% of your available credit, your score also suffers that month. It’s a very fine line. Obviously your score doesn’t drop as many points if you’re using only 25%, versus if you were using a whopping 95% or 100% of your available credit.
Don’t ever max out your credit card!

However, if you are RESPONSIBLE FINANCIALLY, and you use your credit cards strictly for rewards, because you have the cash to pay the bill, check this out:
HOW TO MAX OUT YOUR CREDIT LIMIT & STILL HAVE A LOW CREDIT UTILIZATION RATIO:
Here’s another myth debunked – you can still max out your credit card, ONLY because you have a large purchase to make that you can already afford with cash but you want the rewards, and STILL have a low credit utilization ratio to keep your score high.  How?
- Pay your bill early.
Your credit utilization ratio is only from the amount that your billing statement closes at. I have had this happen many times where one of my cards with a $5,000 credit limit hits a balance of $3,000 for the month due to booking travel for friends where I get reimbursed, along with my normal spend, and I will pay part of the balance BEFORE the bill posts so that I don’t have a statement post with 60% of my credit utilization ratio.

It doesn’t affect me as much now since I have a stack of credit cards, so my total available credit is high, so a $5,000 bill could post and it would still only slightly dent my total available credit in my name, but it’s still smart practice to not allow large bills to post at their full amount. You will still get the rewards for all charges made, whether you pay early, or on time. I’d also like to note that a high credit utilization ratio is important to note for each card, and not just your overall limit between all cards.

Your credit report will list a few things:
- Accounts (both open and closed)
- Addresses on File
- Hard Credit Inquiries (important!)
- On Time Payment History (ideally 100%)
- Any Negative Records & Collections (this is bad!)

David Morrison, about to go Mythbusters on credit card myths:
- Opening more credit cards does not kill your credit score. In fact, it will eventually go up!
“David, what?! Seriously?! But I heard on the radio… But Dave Ramsey said only have one… But……”
- Fact.

Now I am not a financial advisor, and for legal purposes I have to state that everything on this site is strictly opinion, and you should never act on my advice, and you accept the responsibility of all of your actions.

Now let’s get back to learning about your credit report and the myth that I just proved false. Your scores won’t go up IMMEDIATELY after getting a credit card. They will dip for a little bit, maybe 1-3 months generally assuming the rest of your report looks good, but then as the new account, new on time payments, and new credit added to your total available credit start to weigh in for a few months, it will most definitely come back up if you pay on time every month and don’t max out the card… aka – what we just talked about in regards to your Credit Utilization Ratio.
Since “Accounts” is one of the points on your credit report, you better believe that they matter! Now if you are financially irresponsible, and have lots of credit cards that you’re not paying off, or any in collections, then no, having more credit cards will NOT help you, and I would never recommend for you to get one. For the financially responsible who don’t carry balances on credit cards – getting a new credit card helps you.
Why?

4 reasons why adding a new credit card helps you:

1. Your available credit goes up, therefore your credit utilization ratio goes down – good
2. Your total number of accounts goes up, adding more positive credit history to your report – good
3. A perfect score on credit reports for total number of accounts is 20 or more accounts. If you’ve only ever had 1 credit card (says Dave Ramsey), a mortgage, and 2 car loans, then you only have 4 credit accounts, and your score is nowhere near where it could be. Getting a new credit card gets you one step closer to breaking 20. I broke 20 last year.
4. Your total number of on time payments goes up quicker as you pay more accounts on time, every time. Pay 5 credit accounts on time every month – add 5 new on time payments to your record which is 60 a year. Or add 1 new on time payment to your record every month which is only 12 a year… Creditors want to see strong payment history.
The next post will be wrapping up the discussion on credit scores & reports, and I will be answering reader questions as well. Main topic of discussion: HARD CREDIT INQUIRIES! Come and get the info and start practicing smart credit decisions.

One Comment

  1. Pedro says:

    The blog is cool

    Reply

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