The way that you manage your credit card debt can have a profound effect on your credit score. Some behaviors affect the equation output only temporarily, while others stain your consumer report for seven or ten years, and drag your rating down the entire time.
Therefore, it is important to know which factors affect your score temporarily, and which do damage that is more lasting. Banks report balance amounts monthly, so the amount owed is temporary, and can change quickly.
Negative payment history remains on your consumer report for seven years, while a public record can linger for ten years. Keep these two factors in mind as you consider how to handle your credit card debt while optimizing your score.
When Credit Card Debt Hurts your Score
Having large amounts of credit card debt hurts your credit score far more than it helps. You need to borrow money in order to give the equations some data to make a reliable prediction of future payment performance.
However, carrying large revolving balances is not the type of behavior that demonstrates financial stability. High utilization ratios and debt settlement both suppress your ratings.
High amounts of credit card debt increase your revolving balance utilization ratio, which hurts your score. You calculate the revolving balance utilization ratio by dividing the total revolving balances by the total limits into all your revolving accounts.
Most credit cards are revolving accounts. You have the option of paying any amount above the minimum payments. Charge cards require payment in full every month and do not fit the definition.
A high utilization ratio tends to hurt your score. A high utilization ratio is a sign of trouble brewing on the horizon. One unexpected expense, one job loss, or one episode of disability and everything comes tumbling down.
Credit card debt settlement is an agreement between the bank and the borrower, whereby the bank agrees to accept less than full payment from the consumer on the amounts owed. Negotiating a lower repayment amount does two things that affect your credit score in opposite directions.
- Your balance and utilization ratio return to zero, which helps your score for at least one month. If balances and utilization ratios climb anew, the benefits disappear.
- Your payment status updates to “account settled for less than the full amount due.” This status is a major derogatory item and remains on your report for seven years after the update date.
Overall, settling your credit card debt hurts your score for seven years.
Paying Credit Card Debt Improves your Score
The best way to improve your credit score is to pay down the credit card debt that appears on your consumer report. The equations consider the total balances and utilization ratios based upon what appears on your file.
The key to improving your score then lies with lowering the amount of debt that appears on your consumer report. You can achieve this through consolidation, or by paying the account in full while reducing or stopping new charges.
Credit card debt consolidation programs may improve your score, provided you stop spending, and do not run up a new balance on your revolving accounts. Several things occur when you consolidate. Some factors lower your number while others lift it higher.
The lender will log a hard inquiry when reviewing your application. Hard inquiries will suppress your score temporarily on the bureau report used by the lender.
If approved, the lender will report the new installment loan account to each of the three bureaus. New accounts can two different effects.
- Lower the average age of your accounts, which helps.
- Improve your account mix, which tends to hurt.
When you consolidate your credit card debt using a personal installment loan, the bank then reports a new payment status, and smaller amounts owed.
- A paid as agreed status is better than a delinquent status, which immediately improves your rating. Payment history comprises 35% of your number.
- Your total revolving balances, and revolving utilization ratio will drop, which tends to improve your rating. Revolving utilization comprises 30% of your number.
Paying Balances in Full
Paying your credit card balances in full every month may have no effect on your score at all. By paying the balance in full every month, you no longer incur interest charges. Paying interest does not affect your rating, but the balance amount reported by the bank does.
Paying your revolving balance in full does not guarantee that the bank will update your file with a zero balance. The bank updates your balance at the end of each billing cycle, before it processes your payment. When the bank receives your payment twenty days later, new charges may have accumulated on the account. As long as you keep charging on the account, you never reach a zero balance.