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You can have "perfect" credit habits, and still have marginal credit scores. There are a lot of myths surrounding credit scoring. Below, we clarify one of the most common misunderstandings, and detail how it can crush your home loan terms.....
“But I payoff my credit card balances every month and always make my payments on time. How can my scores be this low?”
The above statement is all too common from those who may not have a clear understanding of the credit scoring system, and face sub-par home loan terms as a result.
Credit scores are a large factor in determining your rates and fees on home loans. A 680 credit score can cost a borrower thousands in fees and interest versus a superior 740 credit score.
Needless to say, it pays to know the rules of the game.
Proportion of Balances to Credit Limits is Crucial
Simply paying off your cards on time and in full each month is not enough. That’s because 30% of your credit score is derived from your ratio of balances to credit limits.
So if you have a $500 limit gas card on which you charge $400 in gas each month, you may be shocked to see the hit on your credit report even if you pay off that $400 each month. That’s because you can’t control when the creditor reports to the bureaus. Creditors generally only report once every 30 days, and it’s often right when your statement is sent out…which is usually before you make your payment.
So while you pay the card off in full each month, your credit report in this example will constantly show 80% usage (balance versus credit limit). And any time your proportion of balances exceeds 30%, you risk a big hit to your credit scores. We’ve seen several “perfect credit” candidates have scores in the 600’s, which can negatively impact terms on all financing, but most specifically home loans.
That’s why we recommend never, at any given point in time, charging above 30% of the credit limit on your credit cards. That 30% limit applies on each individual card, as well as all your cards in total. If you have a card on which you need to charge $3,000 per month and you only have a $5,000 limit, contact your creditor and ask them to give you a credit limit increase based on your history with the company (don’t let the creditor pull an inquiry on your report). That way if you get a limit increase to $10,000…you’ll now meet that 30% mark with the $3,000 monthly charges.
Of course if you don’t trust yourself with the higher credit limit, it isn’t worth getting limit increases and going into more debt just to improve your credit scores.
We’ve spent over 16 years specializing in credit reporting. Contact us with any questions…we’re happy to help!