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When building credit, focus first on on-time payments

By

Speaking of Credit
Speaking of Credit columnist Barry Paperno
Barry Paperno is a freelance writer and credit scoring expert with decades of consumer credit industry experience, serving as consumer affairs manager for FICO (formerly Fair Isaac Corp.) and consumer operations manager for Experian. He writes "Speaking of Credit," a weekly reader Q&A column about credit scoring and rebuilding credit, for CreditCards.com. His writings about credit scoring have appeared in The Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.
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Question for the CreditCards.com expert

Dear Speaking of Credit,
I have two questions so I hope you can help me.

1) I am in a Debt Management Program. I still owe $12,000 and plan to have it paid off in two years. In February 2014, I was approved for a Capital One Quicksilver and used it responsibly always on time and kept credit utilization way below 30 percent. I am establishing new credit while paying down old debt on closed accounts, so that when the DMP is finished I have already established new credit and I will be ahead of the game. Do you think this will work if I use the new credit card responsibly?

2) I charge something small and affordable each month, but I make sure to pay it off shortly before the payment due date. I have done this for the past six months, but I always see a small balance due on my statement, which was reported to my credit report. The only month $0 was reported was when I paid the bill as early as possible. Do you think it is to my benefit and would it increase my credit score maybe down the road? Thanks -- Mr. Harvey

Answer for the CreditCards.com expert

Dear Mr. Harvey,
You are very clearly on top of what it takes to rebuild and establish new credit. By entering into a Debt Management Plan (DMP) to pay off existing debt, while adding additional positive credit via your new card, you're laying a solid foundation for that good credit score "down the road."

My only concern is that you may be overmanaging one aspect of your credit score, the credit utilization (card balance/limit percentage) calculations that evaluate how much of your available credit is being used. What you're doing is paying at just the right time during the monthly billing cycle so that only a small balance shows on your statement. While timing your payments in this manner is a very effective and increasingly popular way to maximize your score by minimizing your utilization, I'm going to tell you why it just may not be necessary at this stage of your credit rebuilding process.

To understand the multiple ways in which credit utilization impacts your credit score, there are some important factors to be aware of:

  • Utilization is considered on an individual account basis.
  • Utilization is considered on a combined account basis.
  • Whether individual or combined, only the current month's utilization is considered.

I bring up the first two points to emphasize that, whereas a low balance on the Quicksilver card will lead to low -- probably in the single digits -- utilization for that card individually, when combined with your other card(s) carrying the $12,000 debt being paid off through the DMP, your combined utilization is not likely to be nearly so low. I bring up that last point as a way of assuring you that, as long as your focus remains on the road ahead, your current credit utilization doesn't mean all that much anyway. Here's why.

Some credit scoring factors are based on historical as well as current information, with the most notable examples being those within the "payment history" credit scoring category that accounts for 35 percent of your score. Here, not just the present, but past payment performance going back seven years and more can be included in your current score.

Then there are other factors that don't look at historical along with current information, such as those within the "amounts owed" category, making up 30 percent of your score. Credit utilization accounts for a large part of this category, with only currently reported balances and credit limits having any impact on a score calculated today.

For this reason, and because you're looking long term, instead of focusing on current utilization as you've been doing, I'm going to suggest three simple-but-important guidelines to follow over the next two years until your DMP is completed:

  1. Make all payments on time each month without fail.
  2. Don't take on any new debt.
  3. Avoid paying finance charges.

This means that, for the time being, you don't have to concern yourself with establishing additional new credit or worry at all about your current credit score, as long as you follow these guidelines. But what happens if there are times when you can't? Things happen, so if you need to max out that Quicksilver card because of some car repairs or there's a large medical bill one month, don't worry, as long as you can pay it off by the next due date. Or, if you can't manage that, stretch it out over the next few months if you have to. Just know that two years from now, when your DMP has been successfully completed, your score won't care about any past utilization.

I hope I have addressed your questions, but to be sure I'll summarize what I've said. There's absolutely nothing wrong with managing your credit utilization as you've been doing. In fact, it's exactly the right strategy for keeping that utilization percentage as low as possible. All I'm saying is that, given the DMP and your rebuilding timetable, you can make life a little easier by saving that strategy for two years from now when that large debt is history. Then, if you follow my suggestions, you will not only be debt-free with at least one good open card and at least two years of perfect payment history, you'll also have that good -- if not very good -- credit score to tend to.

See related: Forget the 30 percent credit utilization 'rule' – it's a myth, Credit rehabilitation programs don't do anything you can't do, Can self-hypnosis apps help you think your way out of debt?

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Published: January 15, 2015


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