Individual vs. combined utilization: Which one has greater effect on score?

Speaking of Credit with 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  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 on Huffington Post, MSN Money, CBS Money Watch and other consumer finance websites.

Ask Barry a question, or see if your question has already been answered in the Speaking of Credit answer archive.

My overall credit utilization is 48 percent – but some cards have $0 balance and others, a 90-percent utilization. Will a balance transfer to even out utilization across accounts improve my score?

The presence of at least one account with high utilization can hurt your score, even if your overall utilization is low. Therefore, spreading out your balances in order to keep a low utilization across all accounts is best.
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Dear Speaking of Credit,

I recently paid off a number of credit cards, but I still have some with 90 percent utilization. My overall credit utilization is about 48 percent.

Should I transfer some of the balance from the high utilization credit cards to the ones with zero balance?

I was not sure what helps my credit score more – more cards with $0 balances or more with a lower utilization?

Transferring balances won't impact my overall utilization. Since I paid them down as much as I could, in the end I will still be at 48 percent. – Matthew

Dear Matthew,

It’s always great to hear of credit cards being paid off. And it can be great for your score when they continue to be used and paid in full every month.

Yet there are times when transferring a balance from a “highly utilized” card to one that was recently paid off can make sense, whether money-wise or score-wise.

Credit utilization – the amount you have borrowed compared to your credit limits, where lower is always better – is the second most important factor in credit scoring calculations, after making on-time payments.

For instance, taking advantage of a lower interest rate via a balance transfer can be an effective way to save on interest and pay down the debt faster.

Or if moving balances to optimize your score is the goal, transferring debt from a low-limit card to one with a higher limit can often add a few points to your score, as part of the individual utilization calculations that we will be the focus of this discussion.

It is understandable you would question whether having more cards with $0 balances or more with lower utilization is best for your score. Unfortunately, and as you’ll see, the answer is not an easy one.

Predicting balance transfer’s effect on credit score: It’s complicated

Whereas most credit actions can be reduced to either charging or paying – one good, one bad for your score – balance transfers tend to be a little of both. One card gets better, one gets worse.

And as such, their impact on your score, especially from a utilization perspective, can be harder to predict than just a raising or lowering of the total debt.

 

Video: What is your credit utilization ratio?

To see why, let’s take a look at how credit utilization is calculated by the FICO scoring formula, keeping in mind that there are two major card utilization measurements: overall and individual card utilization.

Overall (combined) card utilization

Here all of your balances are divided by all of your credit limits to arrive at a single utilization percentage.

This calculation tends to be both easy to understand and predictable – lower percentages are always better for your score – and remains generally unfazed by balance transfers.

Overall utilization is also the most influential of the two utilization measurements, which together add up to almost 30 percent of your score.

Individual card utilization

Unlike overall utilization, this set of calculations is neither easy to understand nor predictable when a wide mix of utilization percentages makes up the overall utilization rate.

With some percentages increasing at the same time others are decreasing, as tends to happen with a balance transfer, there can be no way for a consumer to know if, for example, one card’s utilization drop is helping the score more than another card’s rising utilization is hurting it.

In other words, it can be hard to know if a particular action you’re about to undertake, such as a balance transfer from a highly utilized card to one with a low utilization, is more likely to help or hurt your score..

Tip

Tip: Keeping an overall low credit utilization – the amount you have borrowed compared to your credit limits – is key to keeping a high credit score. However, having at least one account with a high balance can hurt your score, even if your overall utilization is low. Make sure your score won't suffer by spreading out a low utilization across all your accounts.

Why individual utilization matters

Why does the score look at utilization on an individual card basis in addition to overall?

The researchers at FICO discovered that even when overall utilization is low, just the presence of a single highly utilized card can be an early indicator of higher future risk.

Therefore, when considering individual card utilization, it can be better for your score to achieve, say, 30 percent overall utilization while looking more like Example 1 than Example 2 in the following chart:

Overall credit utilization: Two (very) different scenarios

Example 1

Card A Card B Overall utilization
30% 30% 30%

Example 2

Card A Card B Overall utilization
60% 0% 30%

Impact of individual utilization on score is hard to predict

Due largely to the complex and secretive nature of the credit scoring formula, the kind of scoring information needed to accurately predict the outcome of a balance transfer, such as which percentages are considered good and bad, is simply just not available to consumers.

That is, for utilization percentages closer to the middle of the 0-100 percent utilization spectrum, we have no way of knowing which are considered too high to be helping your score.

We do know, however, that your score can suffer from having too many accounts that are too highly utilized or too few that are lowly utilized. Again, we just don’t know where those lines are drawn.

Balance transfers come with a cost, regardless of effect on score

Balance transfers don’t come cheap. Most come with a balance transfer fee, typically amounting to 3 to 5 percent of the transferred balance.

Of course this fee gets added to that balance regardless of whether the balance transfer did or didn’t help the score.

The slow-but-sure method to improve utilization

Considering the unpredictability of balance transfers on your score and the cost, perhaps you should consider a score-building alternative.

This option also addresses those highly utilized cards, but in a slower, more methodical and cheaper, way.

Simply start reducing the number of your most highly utilized cards by following this monthly three-step process:

  • Calculate utilization for each open card with a balance (balance divided by credit limit).
  • Make minimum-only payments on all cards but the card with the highest utilization.
  • Apply as much as you can to the card with the highest utilization.

Doing this each month, while keeping your total card debt in check, can steadily add points to your score by lowering both your overall utilization and the number of highly utilized cards.

Just keep in mind the potential cost in interest that might come with this alternative.

If the cards to which you will only make minimum payments have an interest rate much higher than the card with the highest utilization, you might end up paying more in interest. Do the math before making any decision.

Whether you follow this plan or try the balance transfer route, good luck!

See related: Sudden spike in credit utilization can cause major score drop, Forget the 30 percent utilization 'rule' – it's a myth


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Updated: 07-17-2018