What Common Credit Utilization Myths Have You Debunked For Clients?


    What Common Credit Utilization Myths Have You Debunked For Clients?

    In the realm of credit management, myths often circulate about the best practices for credit utilization. From a Managing Member's perspective on the 'Zero Balance Myth' to the nuanced understanding that self-credit checks don't damage your score, we've compiled insights from industry professionals alongside additional answers. These responses aim to clarify misconceptions and provide a clearer picture of how credit utilization truly affects your financial health.

    • Zero Balance Myth Debunked
    • Some Utilization Boosts Scores
    • High Utilization Not Always Negative
    • Closing Old Accounts May Lower Scores
    • Maxing Out Credit Can Be Manageable
    • Self-Credit Checks Don't Damage Score

    Zero Balance Myth Debunked

    From my experience as Managing Member at LawsuitLoans, one common credit utilization myth I've debunked is that maintaining a zero balance on all credit accounts is the best way to improve a credit score. While it seems logical that not owing money would reflect positively, credit scores actually benefit from demonstrating responsible credit usage. This means using credit cards and other lines of credit moderately, and making payments on time, rather than not using them at all. Lenders and credit scoring models look for evidence of managing debt responsibly, which includes using credit judiciously and paying it off consistently.

    In practice, I advised a client who was seeking to improve their credit score in preparation for a large business loan. The client had previously kept their credit card balances at zero, mistakenly believing this would maximize their credit score. I recommended they begin using their credit lines for small, manageable purchases and pay these off in full each month. This approach helped demonstrate active and responsible credit use, which gradually improved their credit score. Over six months, the client’s score increased by 50 points, which significantly enhanced their terms when securing the business loan.

    Jared Stern
    Jared SternManaging Member, LawsuitLoans

    Some Utilization Boosts Scores

    Many people believe that maintaining a credit card balance with zero utilization will enhance their credit score, but credit analysts clarify that some credit activity is actually beneficial. A small utilization rate indicates to lenders that you responsibly manage credit without overextending yourself. It's a signal to credit bureaus that you're an active user of credit who pays back on time, which has a positive impact on credit ratings.

    Zero percent utilization suggests to creditors that you may not have recent experience managing revolving credit lines, which can be equally detrimental. To help maintain or improve your credit score, consider small, manageable purchases with timely repayments.

    High Utilization Not Always Negative

    A high credit utilization ratio is often thought to be a surefire way to decrease a credit score, yet this isn't an absolute truth. If you frequently approach your credit limit but consistently pay your bills on time, credit analysts take notice of your reliability despite the high utilization. Moreover, if high utilization is a temporary situation due to an extraordinary expense, your score can recover with subsequent lower utilization.

    In addition, those with long credit histories and diverse accounts may not see as significant a drop when their utilization spikes. If you're currently using a lot of your available credit, aim to bring your balances down over time to see potential improvements in your score.

    Closing Old Accounts May Lower Scores

    Contrary to popular belief, closing old credit accounts is not a guaranteed method for raising credit scores. Long-standing accounts contribute positively to the length of credit history, an important factor in credit calculations. Upon removing an aged account from your credit report, the average age of your accounts decreases, potentially lowering your score.

    In addition, closing old accounts reduces your total available credit, which could increase your overall credit utilization ratio. Before closing any longstanding accounts, consider how it may affect your credit history and explore other ways to manage old credit lines.

    Maxing Out Credit Can Be Manageable

    It's a common misconception that using up to your maximum credit limit will assuredly lead to a drop in your credit score. Credit analysts point out that while high utilization ratios can be a red flag, they are only one piece of the puzzle. Payments history, debt-to-income ratio, and the types of credit in use are also critical components of your credit score.

    As occasional maxing out might not be harmful if it's paid off promptly, serially hitting your limit without repayment can show a pattern of risky behavior. If your credit utilization is high, consider spreading your expenses to avoid maxing out or paying down existing balances promptly.

    Self-Credit Checks Don't Damage Score

    Frequently checking your own credit score is mistakenly thought to damage it. When you check your own credit, it results in a 'soft inquiry,' which does not impact your credit score at all. Credit analysts stress the importance of monitoring your credit, as it allows you to keep track of your financial health and identify any mistakes or fraudulent activities early.

    Staying informed about your credit status is a responsible financial habit that can help you make better credit decisions. Make a habit of regularly reviewing your credit report. It's a step toward ensuring that your financial profile remains accurate and strong.