Ask the Wealthy Bloggers - FICO Scores
By Mike Hillyer | Related entries in Credit Cards, Debt ManagementOk, on to another question from our Ask the Wealthy Bloggers post:
I am trying to build my credit history and just recently got my first credit card, a secured one from the bank, so that the information about me would get sent to all the credit reporting agencies.
However, I am getting contradictory responses on what my spending should be. I don’t really need credit at this moment, so I am promptly paying off every credit card by the end of the billing cycle, incurring no outstanding debt. However, some people told me that I actually should incur some debt and pay off some interest for the credit rating to improve.
So what’s better for credit ranking - promptly paying off or generating some debt and then paying it off?
Oh, yeah, we’re talking USA financial system here.
From: Alex Moskalyuk
By secured do you mean one linked to your account balance? I am going to do a bit of speculation here, but I would assume that a card that does not involve actual granting of credit by a lender is not going to affect your credit rating. Let’s assume you are talking about a card where you are granted credit by a lender though.
What you are working on is your FICO score. You may recall that I wrote about FICO scores previously, and talked a bit about how the score was calculated.
The following breakdown of a FICO score is taken from http://en.wikipedia.org/wiki/FICO_score:
* 35% punctuality of payment in the past
* 30% capacity used, i.e., ratio of current revolving debt (e.g. credit card balances) to total available revolving credit (e.g. credit limits)
* 15% length of credit history
* 10% types of credits used (installment, revolving)
* 10% amounts of credits applied for in the recent past
So let’s look at how to apply this:
1) Always make your payments on time, if you can’t make a payment on time, do NOT take more than 30 days past the due date. Credit reports do not track payments that are less than 30 days late. As you can see, making your payments on time accounts for 35% of your credit score.
2) Do not carry a balance if you can avoid it, keep a low balance otherwise. The closer you get to the limit on your credit cards, the worse the 30% of you score allotted to capacity gets.
3) Play the waiting game. As you can see, 15% of your score is about how long you have had your accounts in place. There is nothing you can do about this 15% except get some credit and make your payments for a while.
4) Try an get some installment credit as well. Creditors see credit cards as dangerous when you apply for credit. I like to call this the ‘run for Mexico’ factor: If you decide to cut all ties and run for Mexico, you can draw out the available balances on all your cards and head for Tijuana. If you have installment credit, all you can do is stop making your payments. If your local bank will make small loans, look at taking out a small personal loan (maybe even offer cash collateral if they consider your credit history to be too new), then just make your payments. If you need a vehicle a small vehicle loan also counts for installment credit.
5) Don’t apply for every offer you get in the mail or at a department store. The more applications for credit you make, the lower your score can get. This once again can be the ‘run for Mexico’ factor: creditors have to wonder if you are applying for a lot of stuff just to build up a wad of cash and try to disappear (or at least more than you can afford, making you look less responsible).
Anyway, to answer your question directly, I would say prompt payment is better than building up a balance on a credit card, but also look at getting a small installment loan (even $500) to help show some installment credit.
Any advice from our fellow readers?
This entry was posted on Tuesday, July 19th, 2005 and is filed under Credit Cards, Debt Management. You can follow any responses to this entry through the RSS 2.0 feed. Responses are currently closed, but you can trackback from your own site.
July 19th, 2005 at 9:57 am
I posted my experience on getting a secured installment loan on Irregular Payments a while back:
http://irregularpayments.com/2005/04/10/some-bad-decisions/#comments
July 19th, 2005 at 4:27 pm
Thanks, that clarified a lot of things. I was advised to keep the balance high (but pay it off on time) in order to increase the credit limit, but I can see now that it can hurt as well.
July 19th, 2005 at 6:54 pm
I would say that your FICO score should only be a concern if you plan on taking out a large loan in the near future (1 year). If you have a car and a house, the value of your FICO will diminish. That being said, your FICO is never worth $$$… don’t be carrying a balance for the sake of bumping up your FICO because of your reliability. Use an auto loan or mortgage to prove reliability.
As for credit limit increases, just periodically ask after you’ve had a card open for 6 months… they’ll usually grant you a small one without any questions and if you want a bigger one, you’ll need to provide employment information.
July 20th, 2005 at 7:27 am
Jim: sounds a bit like putting the cart before the horse, in order to get that auto loan or mortgage to prove reliability you need proven reliability.
July 20th, 2005 at 7:45 am
I agree and disagree…
Keeping high credit card balances close to your limit hurts. However I would say that keeping zero balances hurts as well because creditors won’t be able to judge your ability to pay month to month.
I generally keep about a 20% to 30% balance on my lowest rate credit card. So if the limit is $10K, I’ll keep about $2K on it and pay it off in 3 months. Also paying more than your minimum payment in your credit cards, auto loans and mortages is the easiest and fastest way to increase your FICO Score.
Jim, your FICO Score is worth $$$ and lots of it. FICO Score is the most important financial asset one can have. Without it you will never be able to have a car, house, even a job as many employers now perform credit checks as part of their employment application process.
July 20th, 2005 at 9:41 am
When I say your FICO isn’t worth money, I mean it isn’t worth carrying a balance, accruing interest, in order to get, what you believe, is a higher FICO. The FICO is important because it determines whether you can get a loan and how much of a loan you can get.
When I bought my house, I had four things that detracted from my score:
1) Length of time of accounts open (oldest CC was only 5 or 6 years)
2) Too many inquiries (I applied for 1 CC in the last year, so their horizan goes back farther)
3) Too few revolving account balances (this very issue of carrying a balance or not to carry a balance)
4) Length of time since most recent account open (that CC I applied for)
My score was 724 - so is carrying a balance “worth” it?
July 20th, 2005 at 9:59 am
[...] ying a Balance to get a better Credit Score I’ve been participating in a discussion over at the Wealthy Blogger about whether or not y [...]
July 24th, 2005 at 10:58 am
My take on this reflects that of the author.
Pay it off unless and otherwise it’s a 0% apr card.
Johncy Edward
http://your-credit-score-n-you.blogspot.com/
July 29th, 2005 at 7:30 am
a bit late to add, but I’m gonig to have to agreed with the 5 things listed above. Also, the person that ask the question was probably referring to a secured credit card (majority of credit cards are unsecured). Secured cards shows up as open revolving account too, the only difference is that in the case of your non-payment, the bank can take money from whatever account the card is secured against.
There’s no reason to ever keep a balance (unless its 0%), it doesn’t build any better credit. A creditor can see you pattern of payment via your credit reports whether you pay it off in full or not. Keeping a balance will never really help your credit score. The closer you get to 50% utilization, the more your score will drop.
On the flip side, too many open accounts (specifically revolving ones such as credit card) = more risk when larger loan lenders view your credit report.
Still to add more to the confusion, some creditors do prefer those that carry balance instead of “deadbeats.” Its true that if you carry balance you may have a better chance in being granted credit via a specific creditor, but personally I wouldn’t want to get credit from those type anyway.
At the end, you can never truly figure out how FICO scores are fomulated, Fair Issac does a good job of making things difficult. Everything mentioned above is based not just on my own personal credit history usage and pattern, but also that of many others.
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