Bill Roeser, CPA, CFP
How do I make the most impact on improving my credit score? And should I pay one card off completely or a few cards down by 50 percent to better impact my overall score?
We know, in a very general way, what most major credit scoring models use as a basis of their calculation, but the actual formulas used are proprietary and the formulas unknown to the public. It takes a long time to build a great credit score but the following information will get you off on the right step.
To begin, here’s a list of items and relative weight examined in the FICO scoring model, which is one of the more popular, widely used models:
- Payment history (35 percent)
- Amount owed to all creditors (30 percent)
- Length of credit history (15 percent)
- Amount of new credit (10 percent)
- Types of credit in use (10 percent)
As you can see, the payment history is the most important but the second item is amount owed to individual creditors.
Credit Utilization Ratio
Your credit score judges your “amount owed to creditors” level not as a measure of your overall debt, but as a percent to overall debt. If you used $10,000 of a $20,000 credit limit you would have the same credit utilization ratio (50 percent) as someone who used $500 of a $1,000 credit limit. The dollar amount in this matrix does not matter; it's how much of your available credit have you used as a percent to the limit..
Generally speaking, the lower your credit utilization ratio is the better it is for your score. Most experts suggest trying to stay below 30 or 40 percent utilization, with your score likely to suffer once you go over 50 percent.
It’s important to note, however, that FICO factors credit utilization in two ways – on an account-by-account basis and as an overall reflection of your debts and limits. This means that if the utilization ratio is low on most of your cards, but one of your accounts is close to its limit, that will likely have a negative impact on your overall score.
So to decide which cards to pay off, review your credit limits and debt totals on individual cards. If you’ve got any accounts where you’re using more than 50 percent of the available limit, that is where you want to start. If the utilization ratio is below 30 percent for all of your cards, I would suggest focusing on whichever account has the highest interest rate. That's an economic decision; it does't impact your score.
Credit Scores - Federal Trade Commission
The Federal Trade Commission is responsible for regulating credit score information. See their website for more information:
Bill Roeser, CPA, CFP