It's More than just Paying your Balances

Paying off your monthly credit card balances is a good thing to do - a very good thing. As a matter of fact, it's what you should be endeavoring to do. But did you know that simply paying your monthly balances isn't enough to raise your credit score? The truth is that you'll have to watch a few other things as well. Let's take a closer look to understand why.

You see, one of the factors that the FICO credit-scoring formulas take into consideration is the total amount owed on all of your accounts in relation to the total amount of credit that you have available. In other words, it measures the percentage used of your total available credit. For instance, if you have two credit cards that each carries $1,000 spending limits and you've charged $200 on both of them, the amount of available credit that you've used is 20%. According to Fair Isaac Corporation, the company whose formula model is used to determine your actual credit score, the average American uses just over 30% of his or her total available credit. Using substantially higher percentages than this can cause lenders to get somewhat nervous. This is because people who max out their credit limits, or those who even come close, tend to have considerably higher rates of default than consumers with lower debt ratios. So, carrying higher percentages of debt could potentially lower your score.

But why would that affect you if you pay your balances in full every month? Typically, the balances that are reported to the credit bureaus are the ones which are on the monthly statements that you receive; in other words, the balance at the end of the billing cycle. So even if you pay off that $1,500 purchase you charged last month on the day that you receive the bill, a balance of $1,500 is reported to the bureaus. And the credit reporting agencies don't make a distinction between the balances that you pay off immediately and those you carry from month to month. With that large reported balance, your percentage used of total available credit (the debt ratio) rises dramatically, and your score will likely suffer as a result.

Another effective strategy that should be employed to improve your credit score is to have a good "mix" of credit. For the highest possible scores, you should have credit in the two major credit categories: revolving credit and installment credit. Revolving (or open-ended) accounts include credit cards, department store-and gas charge cards, and the like. Examples of installment debt are mortgages and car loans, accounts that generally have a finite number of payments (these accounts don't necessarily have to still be open, but they do need to still show on your report). Although you don't need to have a loan of every type, having credit in each category is important.

The age of your accounts -- and your credit history in general -- also factor into your credit score; and in this venue, older is definitely better. If you have older accounts which you don't use, it may not be wise to close them. Even if an account has a bad rating, if it's still being reported as open, the age of the credit line could be significantly aiding your score. Closing older accounts could make your history seem younger than it is, and that won't help your credit score; in fact, it may damage it.

So, paying off your charge balances every month is an excellent tactic with a number of benefits, but remember to keep a lid on your amount of credit use. Limit it to below 30% or less of your available credit if at all possible. Do your best to diversify your file with different types of accounts. And be mindful of the age of your overall credit history. Your credit score, and your wallet, will both benefit.