The "Rule of 22"

If you have ever read any of my books or any other articles I have written you undoubtedly have heard me talk before about the importance of how you manage your credit card debt in the eyes of your FICO score.  Some of the concepts and principles I teach I understand can be a bit confusing at times, so in an attempt to help you improve your score, but also make it easier, I am going to focus on the number 22 with this article.  By the time you finish reading this, you will understand why “22” is a very important number that can have a significant impact on your score. The key now is to understand “why” it’s important and how you use it to your advantage! 

            Most people have heard before that there are 5 components to your FICO score. They are:  payment history, debt ratio, average age of credit, mix of credit and inquiries.  My favorite (yes I just said that I have a favorite component of the FICO score) is “debt ratio”.  The reason for this is because of the 5 it is the least understood, but represents the single fastest way that with a little bit of knowledge you can positively improve your score in the shortest amount of time.  That to me is exciting!  

            The largest part of this category that is being measured is the balance compared to the limit on your revolving accounts, most commonly your credit cards.  As a simple example, if I have one credit card that is open and the limit is $500 but my balance is $250 that means I am using 50% of my available credit.  It’s simple math but here are the areas where the confusion comes in.  First, people will tell you all kinds of magic numbers or thresholds that you should keep this number under to improve your score.  Usually everyone that tells you that information is wrong.  The best place to be to earn the most points you can in this area of your score is between 0 – 10%.  So keeping your balance under $50 in this example is ideal for your score.  Knowing that and having it reported on your credit report that way are two different things.  A lot of time people understand this, but are surprised when their credit is pulled and find out the balance on the credit report shows something much higher than what they believe it to be.  Since the FICO score is only based on what it see’s on the credit report at that moment in time this presents a problem.  Credit cards have two important dates associated with them. The first is the statement or cycle ending date and the second is the due date.  The statement or cycle ending date represents the day the previous billing cycle ends AND the balance of the card is then reported to the credit bureaus.  Then your paper statement is mailed to you and you have a 21 day grace period in which to make your payment.  This is important because if you know the proper way to manage your credit cards your score might still suffer just because you are not paying the balance down on the right date!  To help you with this I am giving you the “rule of 22”.  Look at your credit card statement and whatever the due date is get in the habit of paying it 22 days BEFORE the due date.  If you follow this approach not only will your balance on the credit report be a more accurate reflection, your FICO score will also improve.  There you have it….The Rule of 22!

The temptation was too much…now what do I do?

The holiday season is now over and for many comes the real downer of figuring out how much money they spent on credit cards and what they should do with the new retail credit cards they opened.  While I express to people all of the time to avoid that situation sometimes that advice is ignored because the temptation of the instant discount off your current purchase at the register is just too much for some.  Now that the dust is settled and you have this new card many are left thinking, “I will just close it right away and whatever damage I just did to my credit score will be fixed.”  To add to that, there are several “experts” out there that will tell you having a retail credit card is bad for your FICO score and the faster you close those cards the better.  What should you do? Let’s take a closer look at this scenario, but this time with accurate factual information.

First off, next year and moving forward if you are in doubt as to whether you should apply for the retail credit card or not, don’t! The reason they are giving you the immediate discount is because a lot of people will pay more in interest over time than the discount they are actually saving in the first place.  These companies are not dumb.   They understand the human spending habits as well as the fact that IF they can get a credit card in your pocket with their name on it, you are much more likely to buy things you can’t afford right now and then pay them extra interest over time on those purchases.  Retail cards are infamous for their subprime-style terms with interest rates well into the 20’s and credit limits as low as a few hundred dollars. Using and carrying a retail card balance will quickly add to the balance and with such low credit limits, modest purchases can result in highly leveraged cards, which lowers your credit score as a result.

But since we can’t go back in time and reverse the application for the new retail credit card you agreed to, let me give you three possible solutions with what to do with the account now:

Close the card immediately

Many people will close the card right away because they only opened it for the discount. That’s fine but you should be aware that closing it doesn’t do away with any damage you’ve already caused to your credit by opening it. The credit inquiry that was posted by the issuer (or issuers) when you applied will still be there and they can lower your score for the next 12 months. And, the newly opened account (or accounts) will be on your credit report likely for the next decade.

Close the Card… Eventually

I believe that if you don’t close the card immediately you shouldn’t close it ever. The unused credit limit, although a small one, is likely helping your credit scores because credit scoring systems like unused credit limits. By closing the card you will lose the value of the card’s unused credit limit. You will, however, still get the benefit of the age of the account, open or closed. There’s a pretty common myth that when you close a credit card you lose the benefit of the account’s age, which is not true. Also retail credit cards don’t charge monthly or annual fees (although that can certainly change), so the cost to simply hold on to the card is $0.

Never Close the Card

If you never close the card, then you’ll always benefit from the card’s unused credit limit, assuming you don’t run up a large balance.  You’ll also always benefit from the account’s age because the credit bureaus won’t remove the account from your credit report, which they’ll likely do after the account has been closed for 10 years.  If you made the mistake and opened the new card don’t make it worse by making another poor choice.  Keep the card open!