By Dan Beck, Credit Management Specialists
How many times can you think of that you had the best intentions, did just about everything right, but the end result turned out to be negative? Some of the most popular advice about how to improve your FICO score is just like this, great intentions, just about all the right advice advise but one key element is not addressed. This key element can take great advice and turn it into devastating results.
A lot of people think they have a handle on what makes up a FICO score, and consequently what needs to be done to improve it. I am certain we have all heard the advice to; “Just pay your credit card off in full every month and your FICO score will improve” or “If you don’t have a credit card, get one and use it, then when the bill comes just pay it off in full every month.” Now this advice is never meant to be misleading or harmful, I am certain of that. The one key factor that is not addressed with this advice is the element of time.
Following the advice can actually cause your score to go down all because one little piece was over looked. For purposes of illustration let’s assume I want to buy a house, I go apply for a mortgage and my scores are a little shy of what is needed to secure a mortgage. The mortgage broker looks at my credit report and trying to be helpful tells me to go get a credit card, use it and then pay it off in full when the bill comes. So being a good listener I go out and get a credit card with a $300 limit. I decide instead of paying cash this holiday season I will just use the card and then use the money I have set aside to pay off the card. A month later I get the bill in the mail, write a check for $300 which pays the card off and takes my balance to $0. I go back to my mortgage broker to pull a new report so I can buy the house I want and to my surprise, and that of my mortgage broker’s, my FICO score is lower than it was the previous month!
To understand why this happened, we need to understand that balance-to-limit on a credit card is actually the second largest component of our FICO score. It makes up roughly 30% of our overall score. Now before I had no credit cards, which is negative to my score, so I followed the advice and did exactly as I was told. I got the new card, used it and paid it off in full when the bill came. The element that was overlooked is by the time the statement comes in the mail the balance has already been reported to the credit bureaus from my credit card provider. The new credit report that I have will show the one credit card I have has 100% utilized, thus causing my scores to drop, most likely severely.
An easy solution to this problem is just a little more education. If we are educated we can avoid a lot of frustration and heartache. If the advice that was given to me would have contained one more step, the plan would have worked perfectly and I would be approved for my new house. We know that balance-to-limit is extremely important to our FICO score. I will also share with you the absolute best percentage to utilize for your credit card limit is 7% for maximum gain to your FICO score. 7% of $300 is $21, so if I would have had a balance on my card of $21 I would have seen the most improvement to my score with this advice. But only if I knew the proper time to pay down my card, this is the ingredient that was over looked from the beginning.
Credit cards have cycles. It is important to know when you’re billing cycle ends. Most cards tell you that date on your statement or you can call and they will tell you. Mechanically what happens is when my billing cycle ends my credit card reports to the credit bureaus that my balance is $300, and then they mail me my statement and give me a 21 day grace period to pay my bill. So you can see that this piece of the equation being over looked is a huge problem. By the time I paid my card off in full, it was too late! The damage has already been done. My FICO score is showing the effects of being maxed out on my credit, even though I just paid it off in full! Talk about frustration.
To keep this original advice from resulting in a negative outcome, all we need to do is know that paying the card when the bill comes is too late. The simple solution or the last part of the advice that I needed to have received should be, call my credit card company and pay it off in full, five (5) days before the billing cycle ends. Now instead of being frustrated and angry, I am a homeowner and I am telling everyone I know how wonderful my mortgage broker is! Just one little thing can have a huge effect to overall success of the advice. Credit education is extremely important, make sure that the advice you follow is from an expert and complete.
