“John, I’ve read on the Internet that if you have a 1% debt to credit limit ratio you’ll have a higher FICO score than if you have $0 balances on all of your credit cards. This sounds crazy to me so I wanted to ask if it was true, or not. Well, is it true?”
Of all the credit score advice on the web that’s incorrect (and there’s a lot of it), that little tip isn’t one of them, but I sure wish it were. It is true that if you can somehow cause your balance to limit ratio on your credit cards to be exactly 1% then you’ll actually earn more points in the debt to limit measurement (formally called “revolving utilization”) than if you were at 0% or anything above 1%.
Here’s the problem with that strategy…it’s nearly impossible to pull off. Think about it. You’d have to have a balance appear on your credit report that equals exactly 1% of the sum total of your credit limits. That means if you have 5 credit cards and $56,000 in credit limits you’d have to have $560 in balances on your cards.
Some of you might be saying, “that’s not hard at all…I’ll just pay off everything but $560 of my card’s balance.” That won’t work. The balance that’s important to your credit score is the one that’s reported to the credit bureaus…not your actual balance after you make a payment. Credit card issuers report the balance from your most recent statement…not the balance after you send them a check.
So, you’d have to pay your balance down to $560 AND not use the card at all until the next billing statement is generated in order to have a $560 balance. But guess what…that won’t work either. You revolved a balance on your card and that means interest will be added to the $560 you owe and that means you’ll be higher than 1% and your strategy is blown.
The only way to accomplish the 1% strategy is to start with no balance then charge UP to a balance that will equal 1% of your aggregate credit limit. When the $560 balance is reported to the credit bureaus you’ll be at 1% and you’ll reap the worthless benefit of being at 1% instead of 0% or some other minimal debt to limit percentage for one month until it changes.
The reason I sound so bearish on this strategy is the ROI simply isn’t there. You’re talking about spending a ton of time strategically spending, making online payments and hoping you got it right in order to collect that last few little bits of credit score points when you should be spending your time perfecting your golf swing. The folks with the highest scores (780+) have an average debt to limit ratio of 7% so if you’re already down there it’s likely that your scores are already pretty good. And, if you getting below 10% isn’t helping your scores then you have bigger fish to fry than a little credit card debt.
Plus, if your approach involves carrying a balance from month to month then you’re essentially paying for the few extra score points with your interest, which I hate. It fuels the fire of the Ramsey soft headed groupies who mindlessly parrot his suggestion that you need debt in order to have good credit scores.
Credit Reporting Expert, John Ulzheimer, is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and CreditSesame.com, founder of www.creditexpertwitness.com, and a Contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. You can follow John on Twitter here