How to Improve Your Credit Score When Paying Down Debt

by Kevin on September 29, 2009

Kudos to you for focusing on paying down your debt. Regardless of what you do from here on out from a credit score perspective, you are already doing the best of all things – paying down your debt.

However, you can make some small mistakes in the process that will hurt the improvement of your credit score. Hopefully, with some advice, you can avoid them.

Don’t Cancel Cards

When you pay off a credit card, it’s very tempting to cancel the card and cut it up into tiny little pieces. Please don’t. Canceling a card will almost always hurt your credit score because of credit utilization. Credit utilization is a calculation of how much of your existing credit limit you are using. When you cancel a card, you are reducing your total credit limit. This will raise your utilization and lower your credit score.

If you really want to be rid of the card, you can try to consolidate that limit into another card from that issuer. So if you have two AMEX or two Citi cards, ask to have the limit consolidated into one card (preferably the older one).

Pay Down Cards Evenly

If you have two cards charging the same interest rate, try to pay them down evenly. One metric, albeit a minor one, in the credit score has to do with the percentage of debt on individual cards. If you have a card at 90% utilization, that looks really bad and scores poorly (it’s FICO risk code #11). It’s unclear if it’s better to have two cards at 50% or one card at 75% and one at 25%, but I imagine the 50/50 split looks better.

So if it mathematically makes sense for you to pay down cards evenly, try to. If it doesn’t make sense, don’t worry about it.

Review Your Report & Score

The first thing you should do, and you should do this every 12 months, is review your credit report. The Fair Credit Reporting Act requires the three credit reporting bureaus to provide you a copy of your credit report every 12 months. You can go to AnnualCreditReport.com to request your copy. Review it for errors or inaccuracies and dispute anything you find.

Second, and this is optional, you’ll want to know where you currently stand. You can use a free service like Credit Karma to get a TransUnion credit score or you can sign up for a free credit score trial service to get your FICO credit score.

Finally, remember that the goal is to pay down debt, not get a good credit score. As long as you don’t lose focus on that goal, you should do well regardless because paying down debt will always improve your score.

If you like what you read, Jim writes daily at his personal finance blog Bargaineering.com and his Twitter @bargainr.

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{ 13 comments… read them below or add one }

Phil September 29, 2009 at 7:50 am

Thanks for this timely article! While paying off my credit cards has been top on my list lately, I find I’m approaching it differently than I once was. Originally, I was shooting for the “Dave Ramsey route:” pay ‘em off and close them.

But now I’m attacking them in stages, and stage one for me is get them all down to 20% utilization (80% of my limit is available – right?).
Once this goal is reached, then I’ll start looking at each card with an eye toward paying them off completely. But then what?

I hear stories of companies canceling no-activity zero-balance cards, so this makes me think if I don’t use them I’ll loose them. If so, I consider using them simply to pay non-discretionary bills (power, phone, etc.) and just use the cash I would have spent on these items to pay off the cards each month instead (“manageable debt?”).

Some questions then…
Is there a “magic utilization percentage?” I get mixed messages on this in my research.
And, for example, if my balance due on a card is $30, where my credit score is concerned, is it best to pay $25 and leave $5 on the card? Instinct says pay it off every month, but would my credit score benefit from keeping a small amount on the card each month and taking the minor interest charge?

I don’t anticipate needing/wanting credit anytime soon, but I’d feel better having no debt with a higher credit score, than no debt with a lower credit score :)

Thanks again for the great post!

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Steve October 8, 2009 at 3:34 pm

Hi Jim,

Not sure I understand your comment about not cancelling credit cards. #4 on the FICO risk code list is “Too many bank or national revolving accounts”. Any idea what constitutes too many? Seems like people with greater than that number should be cancelling accounts.

Steve

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jim September 29, 2009 at 9:28 pm

I don’t think there is a magic number, though some places will say getting it under 7% or 10% is best. I think 20% is a good target and obviously lower is better. However, if you’re making all your payments on-time, that’s a bigger factor that utilization.

That’s a good point about no-activity cards being cut too.

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Scott October 8, 2009 at 5:10 pm

Well, not all issuers will permit one reaching a 20% utilization — one of my cards with a $2500 balance had a $15000 limit (that the card company unilaterally raised several times due to my good payment history…during the last 5 years when credit was torrentially raining down on the population at large) until advance info about the new credit card legislation not yet enacted was made public and then the card company shut the credit limit down to $3000 (I never went over $2800 on the card). So much for maintaining a good credit score. For me, the object is SOLELY to pay down my debt … credit score be damned!!!

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Steve October 8, 2009 at 5:46 pm

Hi Jim,

Not sure I understand your comment about not cancelling credit cards. #4 on the FICO risk code list is “Too many bank or national revolving accounts”. Any idea what constitutes too many? Seems like people with greater than that number should be cancelling accounts.

Steve

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steve in w ma October 9, 2009 at 11:20 am

Using a card once or twice a year is probably enough to keep it active from the credit card company’s point of view. Using it once or twice a year gives them hope that you will begin to use it more often. In the past (when I needed them) I have used this fact to get low balance transfer offers from unused cards: buy something in the month, then pay less than the balance due and incur a small interest fee. Then request a balance transfer check.

I hypothesized that having an interest charge on the account would make me attractive to them as a balance transfer customer, probably because it marked me as a “sucker’ or good customer who would rack up purchase rate interest over my balance transfer interest. It seems I was right, as I would always get more attractive offers from them the month after the finance charge showed on my bill. In fact what I then would do was I would first pay off the full balance, not make any more regular purchases, and just use the balance transfer offer (if it was a good deal) for what it was worth to reduce the overall cost of my outstanding debts.

Now of course my finances are on sounder footing and I have little to no need for such shenanigans. But depending on one’s debt situation, after knowing how to budget and use cash envelopes, I think it is a good trick to have in one’s arsenal.

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steve in w ma October 9, 2009 at 11:26 am

No one really knows all the answers except the people at FICO, and they aren’t telling. And they change their criteria from time to time as well.

I have never had a problem with paying off my cards in full negatively affecting my credit. But if you are concerned with that, just leave them paid off for a year, then run some small balances on them and compare your FICO score before and after. In my experience the score goes down the more debt there is on the credit cards though, so an active card with a zero balance should be no problem.

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john connor October 9, 2009 at 5:32 pm

i know from experience. you need to lower your utilization under 60%, anything above that number knocks your score lower. found that out when refi. one card that was literally 61% and prevented a refi!

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anna October 10, 2009 at 8:50 am

I have a question, I had large credit lines on all my credit cards, my score was 802 and I am NOT KIDDING! However in the last year, the credit card companies had started HACKING away at my credit limits. Example, Amex cut me from $ 15,000 to 2500.00 and I had $ 1800.00 on the card
Chase cut me from 23,000 to $5,000 and I had $ 3200.00 on the card, etc….this DROPED my score to 632 in a heart beat. Bank of America closed a $25,000 line completely for lack of use, etc….So didnt Citibank….
these companys moves have ruined my score….is there anything I can do?
When I called these company’s after my score started dropping, thats what I got told ” Rapid decline in your FICO score”….I was so angry! I support an 83 yrs old mothers bills, via telephone on credit cards and have 2 kids in college. There isn’t 10 cents worth of “mommy shopping spree” on any of these cards….. can I do, anything about this. The lower I pay them off, the LOWER limit they give me…….they are ruining my credit score for paying my bill! Can I put a stop to this….? Ok, How?

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michael December 27, 2009 at 11:16 pm

The same thing happened to me – When Chase lowers my credit limit, this lowers my score, so when I make a large payment to Bank of America, they lower my limit until I have no available balance, etc…

What makes this worse is because as I’ve gone from 50% to 95% utilization (despite paying off a large part of my balance – they just decrease limits more), this lowers my score, and caused my credit card rates to go from 10-20% to 25-30%, and making it hard to refinance or get a balance transfer.

I’ve really learned my lesson on how fickle credit card companies can be.

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Bernie Peterson October 10, 2009 at 10:30 pm

My credit score has been downgraded for having too many cards. I have several with very high credit limits…in the $20K range, but when there is a promotion like a gas card that offers 5% off, I appply for it.

With Shell, I drove so much and charged so much (and paid in full every month) they renigged on their 5% deal. In other words, since I didn’t get behind and pay their 25% interest, they didn’t want to honor their offer. So I don’t buy Shell anymore, and I quit using their card.

I have 4 cards with Chase Bank, again, to get deals on BP gasoline, Amazon purchases, Continental miles, etc.

Then I get this note on a credit report that I have too many cards. So I should shut off some of the inactive ones? But how many is the right number? These credit reporting “services” are morons. They don’t provide any definitive information to the consumer as to what steps the consumer can take to improve their credit score. What’s reallty great is how simplistic their whippy-dippy computer systems are, but they are full of themselves on how great they are. Like Lily Tomlin when she used to do her Ernistine, the phone company operator skits.

I consider these credit reporting agencies to be major players in the great underbelly of the banking system in this country. If the administration had any guts they would include in their “credit card reforms” (LOL) some hard and fast rules for these guys to abide by…like that for any bad or negative report they put in their system, they should have to immediately give the consumer a complete report including contact information either to one of their staff or to the company that posted negative information so responsible consumers can get things straightened out ASAP, instead of having to spend hours doing detective work to figure out what’s up. But no, they try to rip off consumers with the “FreeCreditReports.com” scam where you get your FREE reports if you pay $10 a month for what should be free.

The other thing that really steams me is that individuals do have some Federal laws to help to force the morons to fix their errors. But a small business has no such protection. The morons at one of these outfits attached some other company’s bill defaultsto my company’s record. When I tried to get that matter straightened out the arrogant astards wouldn’t lift a finger to fix THEIR error. It took me a year and dozens of calls to get these creeps to fix their mistake. They should all be taken out and horse-whipped.

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Summer October 23, 2009 at 1:25 pm

what is all the fuss about?? If you pay your bills on time and not worry about extreme high balance credit cards, it will adjust itself in time. DON’T CANCEL YOUR CARDS WHEN YOU PAY THEM OFF! If you keep any credit card at 25% debt then your credit score rocks. How many is too many? Considering over 3 credit bank cards is too many. If you need this much credit then rely on your banker, not a “fuzzy” lender. They don’t give a crap about you! Your banker rocks! They take care of you with a open line of personal credit. What else should you need?? They are not going to flip-flop interest rates, nor will they drop your rate. Be smart aim for a FIXED RATE CARD!! The hell with the floating interest rates, prime “rib” crap. Eat bologna, and stay happy with credit. Hillshire says, go BANK!! My credit score is 810! I have 3 bank cards and 3 gas cards and 48 years old!

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LAWRENCE November 10, 2009 at 9:27 am

WHAT DO YOU THINK ABOUT THE HOME MODIFICATION LAW, IF A HOME OWNER SUFFERD A LOSS IN SALARY DUE TO RETIREMENT AND THE MORTGAGE PAYMENT IS MORE THAN, THEIR SALARY, AND IS NOW IN FORECLOSURE CAN MODIFICATION BE AWARED TO RETIREE PEOPLE FACING FORCLOSURE, AND THE BANK IS NOT WILLING TO SETTLE , WHAT CAN BE DONE AFTER OBTAINING , A, LAWYER TO REPRESENT. THANK, S 11-10-=-2009

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