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Keith: I recently received a phone call from a friend who sounded panicked. He had just received an update that his credit score dropped 30 points!
My friend has 40+ years of credit history, ALWAYS pays his bills on time, and has NEVER carried a credit card balance. I was ~100% certain I knew why his credit score dropped without even having to ask him a question.
Before I hung out with the savvy credit card crowd, I was always told to only have 1 or 2 credit cards at most. Folks said as long as I paid the balances in full each month, I would maintain an excellent credit score. I think this is a huge misconception!
The 1 or 2 credit card rule might be good advice for some. But there’s an important credit score factor many people forget about or are not aware of. My friend didn’t know and that’s why his score dropped 30 points in one month!
Credit Utilization Makes up 30% of Your Credit Score!
30% of your credit score is based on balances owed, which is also known as your credit utilization.
Even if you pay your entire balance off each month, your credit report might show balances that count toward your credit utilization. That’s because most banks report your balance after the statement close date. Some banks (like Chase) even report your balance a few days after you make a purchase.
The longer you wait to pay your credit card bill, the more time your outstanding balance will appear on your credit report. And this has the potential to have a negative impact on credit score. Even if you pay the full balance before the statement due date.
This is exactly why my friend’s credit score dropped 30 points. He only has 1 or 2 credit cards in his wallet. And the credit limit on each card is relatively small.
So after using his cards for some big spending (home repairs, paid vacation, etc.), his credit utilization ratio was very high (above 50%). His credit score dropped 30 points because of this factor alone despite the fact that he paid the balance in full, immediately after receiving the statement.
One trick to avoid having a high credit utilization ratio is to pay credit card bills more than once per month or before the statement close date. I sometimes pay the total balance on certain cards 4 or 5 times in a month. And my credit report typically shows a $0 balance for these accounts.
Paying before the due date is an especially good idea if you make a large purchase during the month. You can pay it off right away to avoid having a large outstanding balance appear on your credit report. So making early payments can be an easy way to boost your credit score!
I Have a Dozen Credit Cards and a Credit Score Above 820!
It’s contrary to common belief, but having several open credit cards can actually help improve your credit score. The key is to NOT utilize a large portion of the credit limit on all of your cards.
That’s why I advised my friend to apply for the Chase Sapphire Preferred® Card. Opening a new credit line will reduce his credit utilization ratio as long as he doesn’t use a large portion of the limit on the new card.
And the Sapphire Preferred is the top card we recommend to folks who are new to miles & points. My friend likes to travel, so he’ll have no trouble using the valuable sign-up bonus to save on airfare, hotels, or rental cars! And even with the drop in credit score, he still has an excellent credit score (750+), so he should have no problem qualifying for the card.
Just to show you how my logic actually works, here’s a screenshot of my credit score.
The key is I have an excellent payment history. And my credit utilization ratio is very low. Across all of the cards that appear on my credit report, I have ~$138,000 in credit available. But my most recent credit report shows I’m only utilizing ~3% of the available limit.
This doesn’t mean you should apply for 10 new credit cards today. Each time you apply for a credit card, the banks look at your credit report. This is known as a hard credit inquiry.
And hard inquiries can have a minor impact on your credit score. But in my experience, the temporary impact of applying for 1 or 2 new cards is usually offset by the long-term benefit of maintaining a low credit utilization ratio.
Paying your credit card bills in full and on time is just part of the equation used to calculate your credit score.
An important factor (30% of your credit score) is your credit utilization ratio. That’s the total balance reported to the credit bureaus divided by the total available credit limit across your credit card accounts.
My friend saw his credit score drop 30 points in one month just because he was using a large percentage (50%+) of his available credit limit. That’s despite having a lengthy history of good payment history.
To help my friend, I recommended he applied for the Chase Sapphire Preferred® Card. Opening a new credit line can help improve his credit score as long as he doesn’t use a large percentage of the available limit.
Have you had a similar experience with a sudden credit score drop?