There is a lot of misinformation about credit scores, but when it’s coming from someone who should know better, I want to scream.
During a recent online discussion, a reader asked me about something a lender told her.
Here’s the backstory: “I am working with a loan officer to refinance a property. This loan officer told me that the best way to boost my credit score would be to leave a small balance on my credit card every month. According to her, if I pay off the credit card in full every month, the credit card companies see a net-zero transaction and therefore don’t report anything to the credit bureaus. Since the reporting history doesn’t change, my credit score doesn’t decrease, but it doesn’t increase either. It just stays the same. She says the best way to increase your score quickly is to pay off mostly everything but leave a small balance every month.”
The advice seemed “counterintuitive,” the reader said.
This person’s gut was right. The advice is incorrect. I would find me another loan officer. What else is she getting wrong?
Before I get to why the recommendation is bad, let’s look at the FICO credit-scoring model most used by lenders.
The basic FICO score ranges from a low of 300 to a high of 850. (There are industry-specific scores that go from 250 to 900.) The two factors that impact your score the most — up or down — are your payment history and amounts owed. Understanding payment history is easy. You need to pay your credit accounts on time — all the time. Late payments can take your score down. In fact, in a recent report, FICO said consumers with a perfect credit score of 850 have no reported history of missed payments.
Having some late payments won’t necessarily tank your score. FICO looks at how recent and frequent you’re delinquent. Being 90 days late is worse than being 30 days late. As each year passes, the late payments have less impact on your score. Most dings will stay on your report for seven years from the date of delinquency. Over time, you can counteract this negative information by staying current with your payments.
FICO also looks at how much debt you have outstanding. The models examine how you manage a mix of credit, such as a mortgage and credit card. Specifically, the model factors in your credit utilization, which is the percentage of amounts owed, compared to your credit limits.
Not all outstanding debts are measured the same. Revolving debts, such as a credit card, typically carry more weight than installment loans, such as an auto loan or mortgage. Consistently paying your revolving account balances off helps improve your score.
Low credit utilization can push you into an excellent credit range. For example, the average revolving utilization for folks with an 850 score is 4.1%.
You may have been told that if you keep your utilization below 30%, you’re good. But that’s just a benchmark used to discourage overextending yourself. If you want to be like folks with an 850 score, you need to keep your utilization in the single digits for each card and overall.
So let’s get back to the advice of carrying a credit card balance. I asked real estate expert and columnist Ilyce Glink what she thought of the reader’s case. Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask.”
This person is “getting terrible advice,” Glink said. “You don’t have to run a balance to have a higher credit score. Ever.”
Glink says it’s all about on-time payments and how many different types of open lines of credit you have — car loan, mortgage and student loans, credit cards, etc.
If you want to get the best mortgage loan deal, here’s how you raise your score, Glink says.
• Preferably pay off all debts owed at the end of the month. But at least pay your monthly minimums on time.
• To boost your credit score, make sure you have at least two open credit cards, and pay those off each month. A lender may want to see that the card is active but that just means you’re using it. You don’t have to have a rolling balance.
• If you have a balance, then don’t use more than 30% of your total available credit per card. So, if you have a maximum credit limit of $1,000, don’t run a balance of more than $300.
What’s key to a good credit score is handling your debt responsibly — month after month after month. But as soon as you can, get rid of it, because you don’t need to keep it around like it’s a pet.
— Washington Post Writers Group
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