The Balance You Owe vs. Your Available Credit Lines – 30% impact on your credit score. Keeping your credit balances below 50% of your available limit is very important. Keeping your balances below 30% of your available credit is even better. This is perhaps the single most misunderstood part of credit scoring. There are a lot of misinformed people that don’t understand how the credit scoring systems work, and yet they insist on pretending to be experts in this area. Here are just a few of the common myths:
- You should close all your credit accounts if you are not using them.
- You should not have credit accounts appear on your report after they have been closed.
- You should not have any open credit card accounts at all.
- You should not have high limits on your credit lines.
First of all, the credit scoring system looks at the percentage of debt that you owe compared to your overall credit lines – not the amount of credit that you have available to you. For this reason, most of the time it is better to leave your credit accounts open. By not using the credit that is available to you, the system regards you as having enough financial restraint and discipline not to overload on debt.
Remember, the credit scoring system looks at the percentage of debt you owe compared to your overall credit line.
For instance, if you owe $10,000, and you have $100,000 of credit available to you, you are only using 10% of your available credit line. On the other hand, if you owe $10,000 and you only have $20,000 of credit available to you, you are using 50% of your available credit line. This is negatively interpreted by the credit scoring system as being a strong dependence on credit. Furthermore, if you owe $10,000 and you only have $10,000 available to you, you have “maxed out” your available credit and your credit scores will be very negatively impacted. Therefore, it is not how much you owe, but how much you owe compared to what you are able to borrow.
Additionally, if you have no debt and no credit lines open or available to you, you will end up with a lower score than someone who has no debt and a few lines of credit available to them. Financing is a game of percentages and ratios. The credit scoring system does not look at the dollar amount of debt you have; only the balance you owe, compared to how much credit is available to you.
Here are three practical steps to improve your credit score in this area:
- Do not close your credit accounts unless it is necessary to do so. It is better to have many open accounts with little or no balance than to have just one or two accounts regardless of the balance.
- Do not concentrate large balances on just a few accounts. Pay outstanding debt down as close to zero as possible, and evenly distribute the remaining balance across all your open credit lines. The key is to keep the balances down below 30% or at the very least 50% of your available credit line(s).
- Call your credit card companies and try to increase your available credit lines if they can do so without pulling a new credit report.