In general, using as little of your credit card limits as possible is better for your score.
So logic would suggest that paying off your credit cards early so that a zero balance is reported to the credit bureaus would produce the highest scores, right?
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Turns out, having 1 per cent of your credit limits in use may help your credit score even more than showing 0 per cent usage. Counterintuitive as it is, that's how credit scoring works.
Why 1 pct is better than 0 pct
Credit scoring systems are designed to predict how likely you are to repay borrowed money. The two biggest factors - accounting for about two-thirds of your credit score - are paying on time and the amount you owe.
Credit utilisation, or the percentage of your credit card limits you use, is one of the biggest levers you can pull to affect your score, and it works quickly: Your utilisation changes as soon as card issuers report your new balances to the credit bureaus each month.
If you are trying to squeeze every possible point from credit utilisation, the trick is to aim low - just above zero. Credit expert John Ulzheimer, who has worked for US-based credit bureau Equifax and credit scoring services firm FICO, says that data has shown that 1 per cent credit utilisation predicts slightly less risk than 0 per cent, and scoring models reflect that.
Tommy Lee, principal scientist at FICO, explains it this way: “Having a low utilisation indicates you are using credit in a responsible manner.”
How to shoot for 1 pct
If you're aiming for a perfect credit score, or are close to qualifying for a lower interest rate on a loan, shooting for 1 per cent might help you gain a few points. You could aim to zero out your credit cards, knowing that your regular use of the cards will keep some small percentage of your limit in use.
Having a low utilisation indicates you are using credit in a responsible manner.
Ulzheimer explains how: “If you can pay off your balance in full by the statement closing date, then you'll get a statement with a zero balance and that's what will appear on your credit reports.” Or, you can pay off a card in full by the due date and stop using the card entirely for the next billing cycle to get to a zero balance.
“But 1 per cent could be better if you can pull it off,” Ulzheimer says.
You could do that by using the AZEO (all zeros except one) strategy to get every credit card but one to a zero balance. Because credit utilisation is calculated both overall and per card, you may want to use your highest-limit card as the one that will have a statement balance. Simply add all your credit limits together, and figure 1 per cent of that.
You can also try paying online as soon as a transaction posts to keep the balance low. Or, use a personal finance website or your card issuer website to check your credit utilization weekly. Then make a payment to bring it down, rather than waiting for your monthly statement.
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What if I can't make it to 1 pct?
Keeping utilization under 10 per cent is another worthy goal.
Roughly top 25 per cent of credit scorers use about 7 per cent of their credit limits.
If you pay on time and keep balances low relative to credit limits, your scores will generally be high.
Ulzheimer points out that if you are fretting over whether you want a credit utilisation of 1 per cent or 0 per cent, it's worth noting that either is excellent. And it's entirely possible to score a perfect score without the elusive 1 per cent. How that works is part of the “secret sauce” that scoring companies do not reveal.
How to get and keep a high score
Nothing is more important to your score than paying bills on time. The scoring penalty for a missed payment is severe, and a payment that's 30 or more days late can stay on your credit report for up to seven years, an estimate that varies with each country.
Also, use cards lightly and keep balances low to keep your credit utilisation low.
In addition, keep an eye on the other factors affecting your credit score:
- Check your credit reports for errors
- Keep credit card accounts open
- Aim to space credit card applications about six months apart
- Use both installment credit (loans with level monthly payments) and credit cards