Are you using your credit card to pay for just about everything you can in hopes of maxing out the rewards you earn? While that may be good for your pocketbook, it could be bad for your credit, as our reader JL Lagistee is learning. He wrote:
My problem is that I have a rewards card that pays rewards on all purchases, so I charge everything on this card. Consequently my balance on my card is always high. I also pay off all charges in the same month they are charged. So I am never delinquent or miss payments. The credit rating companies downgrade my credit score a couple of points each quarter and never push it up because of this issue.
JL monitors his credit scores through a monitoring service provided by his bank, and he is frustrated with the fact that his scores remain stubbornly average, despite his perfect payment history on this current account. According to the credit monitoring service, the balance on his credit card appears to be the main factor contributing to his mediocre scores.
What can he do?
I spoke with JL by phone and learned that he only has one credit card and it has a $2500 limit. He often charges $2400 a month on that card in order to earn as many rewards as possible, which means his balance is usually very close to the limit.
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JL’s “utilization ratio,” is very high, explains Barry Paperno, Credit.com’s Community Director and a credit scoring expert with many years of experience in the credit industry.
To calculate the utilization ratio, divide the balance on the card by the credit limit. A $2400 balance on a credit card with a $2500 limit results in a utilization ratio of 96%. “Anytime you go above 25% that can be a problem,” says Paperno.
He also explains that the utilization ratio is calculated for each credit card on a consumer’s credit report, as well as for the total credit card limits and balances reported. Since JL only has one credit card, both his individual and aggregate utilization ratios are calculated for this one card — and that means both are very high.
Is there anything JL can do to help boost his credit scores while still racking up lots of rewards?
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1. Ask his card issuer to raise his credit limit. JL is worried this will cause his credit scores if he asks his issuer to consider him for a credit limit increase. While it’s impossible to predict exactly what will happen to his scores with any of the actions we are suggesting here, a single credit check shouldn’t wreak havoc with one’s credit scores.
When a creditor reviews the credit of a current customer, the “inquiry” that is posted to the credit report is often a “soft inquiry,” since it is coming from an existing relationship, rather than from a new lender. Soft inquiries don’t affect credit scores. But even if the credit check creates a “hard inquiry” — which will impact his scores — over time the improvement in his utilization ratio should be greater than the temporary loss of a few points due to a credit inquiry.
2. Spread his purchases around multiple cards. Since JL only has one credit card, he would have to get a new card to implement this strategy. And a new card would cause his credit scores to drop a bit in the short term. But overall, two credit cards is not “too many,” and his credit scores may benefit over the long run from another positive account on his credit reports.
If JL has trouble qualifying for a high limit bankcard, he may want to consider applying for a department store card, suggests Paperno. They are easier to get and “still be included in his aggregate utilization — though not with quite the positive impact to his utilization as a bankcard.” The limits are often fairly low on these cards, though, so JL should be careful not to charge a lot on one of these cards.
3. Try to time his payments and purchases. The goal would be for his payments to arrive right before the issuer reports his account to the credit reporting agencies so his balances will be smaller. For this to work, he would also have to hold off on making new purchases until the balance is reported to keep that figure down. This is going to be extremely tough to figure out, though, because most of the time the issuer can’t even tell you what date your account is reported to the credit reporting agencies. (Some lenders report balances as of the statement date, regardless of when they actually report their accounts to the credit reporting agencies.) So this approach is probably more trouble than it’s worth.
In the end, it sounds like the best strategy is for JL to ask his card issuer for a higher credit limit, and to try to keep his balance below 25% of his available credit until he figures out whether that helps boost his credit score. Staying under 10% utilization is even better — but you can still have a good score with 25% utilization, says Paperno. The added benefit? If he can get his credit scores up, he may get some attractive new rewards card offers in the mail and he can then get a second card, improving that ratio even more.
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Image: William Warby, via Flickr