How charge cards are different in credit scoring formula

Credit limits, utilization aren't a factor, but wise use of the card is


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 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 expert

Dear Speaking of Credit,
I understand the difference between a charge card and regular credit card, in that a charge card is paid off in full whereas you can make minimum payments and incur debt on a credit card. However, I saw mentioned on a blog that charge card debt appears not as a utilization percentage, but that they take the charge card amount and view it as total debt to income. My question is how can that be, since it is paid in full? There is no technical debt since charge cards are paid in full at end of month. Do credit reports just take the previous month's statement's charges and consider that as debt, even though it was paid in full, given it was a chard card? -- Omer

Answer for the expert

Dear Omer,
You are absolutely right in that, with a credit card, as long as you pay at least the minimum monthly payment the remaining balance can "revolve" to future months, while any purchases put on a charge card must be paid in full by the next statement closing date. You also correctly state that, with regard to credit scoring, charge card balances are not included in revolving credit utilization (balance/limit ratio) calculations, though I'll add that this hasn't always been the case. More on that later.

What is debt?
I can see why you don't seem to believe a charge card balance should be considered "debt," since charge card repayment terms require the balance to be paid in full by the next month's closing date. But let me counter with the idea that, from the time a purchase is made using a charge card, to the date that charge is paid, the money owed to the card company is a form of short-term debt.

Previous month's balance
Focusing next on your question about whether credit scores use a previous month's balance to consider a charge card balance as debt, the short answer can be yes -- sort of. That is, however, if you also accept that most other pieces of information taken from a credit report and used in credit scores and in lending decisions, such as credit card balances and payment history, are just as dated. While far from ideal, this time lag seems to be an inevitable credit reporting fact of life, given such a complicated and widely used information gathering and sharing system.

Charge card and credit card scoring impacts
One thing you may also be referring to with your comment about the role of previously reported debt, is how past charge card balances were used in the early years of credit scoring to include charge cards along with credit cards in revolving utilization calculations.

Since charge cards don't have credit limits -- a requirement in the utilization equation -- older credit scoring formulas would substitute the highest previously reported charge card balance, called the "high credit" amount, for the missing credit limit. This, despite the high credit amount not truly being a credit limit and the charge card not truly being a revolving credit account.

Interestingly, along with the high credit amount not being a credit limit and the charge card not being a revolving account, using the highest previously reported balance in utilization calculations often worked to reward a consumer for having run up temporary debt. That's because the more you charged on a charge card, the higher the "high credit" amount used in figuring the credit utilization percentage.

Giving people better credit scores just because they racked up a lot of debt isn't a concept representing consistent responsible credit management, and so that part of the credit scoring formula was changed maybe 10 to 15 years ago. Credit utilization isn't calculated for charge cards.

Charge card activity is counted in the scoring formula in other ways, however. It's included when the scoring formula looks at your payment history (so late charge card payments hurt your score), amounts owed (not utilization, but the number of accounts with balances and amounts owed on accounts), length of credit history, number of new accounts and credit mix.

The debt-to-income ratio, something often confused with the debt-to-limit (or credit utilization ratio), is a calculation most commonly used in mortgage lending evaluations -- not in credit scores -- consisting of the ratio of your monthly gross income to recurring debt, such as credit card, mortgage, home equity, auto and student loan payments.

While not typically an actual component of debt-to-income calculations, charge card balances tend to be considered by mortgage lenders in the form of a requirement that the borrower be able to show bank deposits sufficient to cover any outstanding charge card balances, and that they are paid in full prior to closing. This cash-on-hand requirement is in addition to the funds normally required for closing costs and reserves.

Or, if prior to closing, a charge card balance appearing on the latest credit report has since been paid off, the borrower may have to provide the lender with documentation of the payoff. This is why, as a good general rule, right before and during a pending mortgage application it's best to simply stay away from charge card usage entirely.

See related: Authorized users and charge cards

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Published: December 17, 2015

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