Bursting the Credit Score Myths: Lowering Your Credit Limits Can Help Your Score
Lowering your credit limits definitely will not help your credit score. In fact in most cases this request will likely hurt your credit score. That's because credit scoring companies use what's called the debt utilization ratio.
The way this works is that the credit card company will total all your credit limits. Then it will total your outstanding debt. Suppose you have $20,000 total credit available to you on four cards of $5,000 each. You carry a total of $6,000 in debt on those cards. The debt utilization ratio would be 30% ($6,000/$20,000).
Now suppose you close one of those cards and your total credit available is $15,000 but you still have $6,000 in debt. Now your debt utilization ratio would go up to 40% ($6,000/$15,000). That move could actually lower your score by 50 to 100 points because it looks like you're getting yourself into deeper credit trouble when the credit scoring agency computers calculates the debt utilization score.
If you want to improve your credit score, don't close cards, but do pay down your debt as quickly as possible. People with a debt utilization score of 10% to 20% get the best credit scores as long as they are paying their cards on time.
You do need to use credit cards even if you pay them off each month. If you don't have a credit history you'll find it very hard to get a major loan when you need one.
Lita Epstein has written more than 20 books including the Complete Idiot's Guide to Improving Your Credit Score.
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Reader Comments (Page 1 of 1)
12-06-2007 @ 6:20PM
Chris Whalen said...
"You do need to use credit cards even if you pay them off each month. If you don't have a credit history you'll find it very hard to get a major loan when you need one."
Great idea Lita, keep spending money using credit cards to get a good score. What happens when an emergency hits and you've been living on your credit cards to get the good score that you promote? You'll use the stupid cards! Then, after you miss a few payments, you'll be bumped into that sweet spot of interest rates called 30%. Go ahead and do the math on how long and hard it is to climb out from under several credit cards with a 20% - 30% rate. Is this the kind of sound financial advice we can expect from this blog?
How about this: Pay off and cancel all of your credit cards. Then, save some money incase of emergencies. When you're ready to buy a house, go to a local bank or a credit union that does manual underwriting to get your mortage. You'll look good on paper and can still get a great rate. All of this, with NO RISK.
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12-06-2007 @ 6:33PM
Lita Epstein said...
Chris,
You obviously missed the line just before the one you quoted:
"If you want to improve your credit score, don't close cards, but do pay down your debt as quickly as possible. People with a debt utilization score of 10% to 20% get the best credit scores as long as they are paying their cards on time."
I did not mean to imply that you shoudn't pay your cards down to zero only that you should use them periodically so that you have credit history.
You'll find there are very few banks or credit unions that do a manual credit check rather than use one of the credit reporting agencies and credit scoring. While there are small banks or credit unions out there, they are by far the exception not the rule.
Lita
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