How Credit Cards Affect Your Credit Score
Credit cards can affect your credit score in both positive and negative ways. Officially closing a credit card account will lower your credit score because it (1) might reduce the length of your credit history, which accounts for 15% of your credit score, and it (2) lowers the total amount of credit you have available, which will raise your debt to available credit ratio.
To illustrate this, assume that one person has two credit cards each with a $5,000 credit limit. This person habitually carries a $2,500 balance on one credit card. With two credit cards, this person’s debt to available credit ratio is $10,000/$2,500 [total credit available/total debt]. This means that this person only uses 25% of his overall available credit, which is good. If he closes one credit card, his ratio is now $5,000/$2,500, which will lower his overall credit score since he is now using 50% of his available credit.
Does this mean that one could open new credit card accounts just to improve his debt to available credit ratio? Yes, one can, if he or she doesn’t already have too many open credit card accounts. Too many credit card accounts can also lower one’s credit score.
On the other hand, having an open credit card that you never use can also negatively affect your credit score since, if you don’t use it occasionally, the credit card issuer might stop reporting your activity altogether. Therefore, use your credit cards occasionally in order to help your credit score.
There is another way that credit card use can negatively affect your credit score, even if you pay off your credit card balances every month. Suppose that you use your credit card to purchase gas, groceries, and everything else each month, always spending around $1,500 each month, but when the bill arrives, you pay the balance in full. One would think you would get bonus points for staying out of debt and paying off the balance in full each month, but not when you consider how you look on paper. What is your credit card issuer reporting to your credit report each month — the total amount you owe at the time of the report and that you pay on time, not the fact that you pay your balance in full each month. Therefore, on paper, it looks like you carry a $1,500 balance on your credit card and never pay it off. Therefore, a good idea would be to have two or three credit cards and rotate them, using one for a few months, then using another, so that your credit card company can report a zero balance every few months to the three credit bureaus.
Note that in the months immediately preceding applying for any type of loan, particularly a mortgage loan, it would be a good idea if you paid off your credit cards in full and didn’t use them for awhile, giving your credit card issuer at least one month to report a zero balance to the credit bureaus. The amount of debt being reported on your credit report is a very large factor in determining your credit score and the interest rate you will be granted, which could result in paying tens of thousands of dollars in additional finance charges on a mortgage loan.
Editor’s Note:
We at Jewelry Outlet always want to remind our customers why it is important for them to obtain and responsibly use credit. One helpful way to improve one’s credit is by adding a trade line and then only using a small portion of the trade line. This is an example of utilization, which is 30% of the credit score calculation. Thus with a top score of 850, the utilization category is 255 points of the total credit score (850 x .30).
If someone had one department store trade line of $500, but had maxed out the trade line by charging $500 of goods and services, then this person would lose almost all of the 255 points (out of 850), having a very high utilization of 100%. Thus assuming all other things on the person’s credit report were good, the highest credit score this person could achieve might only be 595 (850 – 255), as this person might lose all points for having a high utilization.
But if this person obtained another trade line (maybe a jewelry store account) for $5,000, now the person’s utilization would be only 9% ($500/$5,500). Thus this person’s credit score would increase, maybe by as many as 200+ points, possibly bringing the score up to over 800.
The person’s interest rate on an auto loan with a 595 score might be as high as 20%, whereas the interest rate with an 800 credit score might only be 2% to 5%. If someone purchased a $20,000 car, the lower interest rate would save $250 per month, for having good credit and low utilization.
This is the power of low utilization. And this why it is important to obtain a jewelry store trade line with a high limit.
Jewelry Outlet is the number one online jewelry retailer to help you enhance, establish and/or rebuild your credit. We offer easy credit terms for people with bad credit, new credit and no credit. Click here to Apply for Credit
Posted by Christian C Culpepper