Lower utilization, higher score, thanks to paying early

This post originally appeared December 1, 2016 on CreditCards.com as “Small credit line? Pay early to boost your score

By Barry Paperno

Dear Speaking of Credit,
I have a credit card that has two late payments on it from two years ago. I only have two credit cards in total (and no other open loans or other credit). This card has been open the same amount of time as my other card (in fact, two months less than my other card). I usually carry a zero balance on both cards (using them only for small amounts, and clearing them each month). Problem is, the two old missed payments are bringing my payment history down to “poor” (97%) and as I don’t have a lot of credit, it’s taking years to get it up. Would I be better off closing this card? It wouldn’t alter my “age of credit” at this time (unless I took out a new loan/card – which I’m not planning on). Thank you. – Charlie

Dear Charlie,
There are times when the best thing you can do is simply more of the same. You’re about to find out how that might just be true for your situation.

Before addressing your questions of whether to close one of your two cards or maybe open a new card or loan, I’ll first recommend one way of perhaps squeezing a few more points out of your score. It uses a rather unusual payment method gaining in popularity among score-conscious consumers: paying early.

Pay before the charge hits the statement

Whether your credit score is good, bad or somewhere in between, paying a card balance before the closing date can minimize the monthly “statement balance” reported to the credit bureau. This is the amount factored into your credit score, such that the less you owe the lower your credit utilization (balances/credit limits) percentage, and the higher your score.

It’s an especially effective tactic for people with small credit lines – a common condition for those  who are new to credit, or who have had payment problems in the pasts. As an example of what lowering the statement balance can mean for your score, let’s say both of your cards have small credit limits of $1,000 and you make $500 in charges that are paid off the following month without interest.

When that $500 balance appears on your statement(s) and your credit report, it is taking up 25 percent of your total available credit ($500/$2,000). In scoring terminology, you are 25 percent utilized.

If, however, you were to pay that $500 before the closing date and not wait for your statement before paying, your balance on that month’s statement would reflect $0 instead of $500. Your utilization then would be 0 percent. Here, by paying that same $500 before it finds its way to the statement and credit report, your utilization effectively drops from 25 to 0 percent. Quite a difference!

Perhaps you’re already paying in this manner? Or your monthly charges already make up a very small portion of your available credit? If either, you may now be doing all you can for your score and deserve a pat on the back.

Close a card?
To your question about closing the card, my answer is: absolutely not! There’s nothing to gain, score-wise, and plenty to lose from closing a card if, before closing, your utilization percentage is already higher than optimal – more than 10 percent. In such instances, your utilization percentage could rise when the now-closed card’s credit limit is removed from those same utilization calculations we’ve been discussing.

To drive home this point about not closing cards, we can look at another illustration using the same balance and credit limit examples as above. This time, we’ll see how closing one of your cards could hurt your score when its credit limit of $1,000 is eliminated from your score’s utilization calculations, as this is what happens when you close a card with a $0 balance.

By essentially cutting your available credit in half following the closing of one card – $2,000 to $1,000 – your $500 statement balance would go from being 25 percent ($500/$2,000) to 50 percent ($500/$1,000) of your available credit. In essence, you would double your utilization by closing that one card!

Open a new card or loan?
Whether applying for credit or accepting a card or loan offer, anyone concerned about their score should think twice before taking on new credit.

In the short run, a newly opened account of any type is more likely to lower your score than raise it, due to the negative impact on your length of credit history and new accounts scoring categories. As a rule of thumb, if you plan to apply for a new mortgage or auto loan over the next six to nine months, don’t take any score-dropping chances by opening a new account.

Yet there clearly are times when opening a new card or loan can help your score, if not immediately, then in the future, such as:

  • Credit card – just as closing a card and eliminating some of your available credit can raise your utilization percentage, opening a new card and increasing your available credit can lower your utilization, given the same balance.
  • Loan – if you don’t currently have any existing open loans, only cards, you could earn more points from the types of credit scoring category that rewards you for using both revolving (card) and installment (loan) credit.

Time is on your side
No doubt, over the past two years you’ve seen how the passage of time has helped heal some of the scoring wounds caused by those late payments. I’m guessing that, as disappointing as your current score may be, your current score is much higher than it was when those late payments first landed on your credit report. Additionally, by paying in full each month, your score likely to be higher than if you were to make only the minimum. So, continue to pay on time, keep paying those balances in full each month, and hold off on opening any new accounts for as long as possible.

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