For most adults who are out of school, there's only one "grade" left that really matters in your life: Your credit score. A good one can save you hundreds of thousands of dollars over the course of your lifetime, and a poor one prevent you from living the life you want to.
In this clip from Motley Fool Answers, Alison Southwick, Robert Brokamp and Fool alumna Dayana Yochim have some advice for a listener who wants to bump up his FICO score by paying down debt, but who is unsure about the rate at which to do it. The reason for his confusion: A credit score simulator suggested that paying off his credit card over several years would give him a far better score than paying it off immediately. The team explains what's really going on in that calculation, and what it's missing.
A full transcript follows the video.
This podcast was recorded on July 12, 2016.
Alison Southwick: The last question comes to us from Trevor. Trevor writes:
I recently purchased a credit report of my FICO because I wanted to know my credit scores in preparation for seeking an auto loan. One of the features of the report was the FICO score simulator, which shows how certain actions can raise your credit score. I was shocked that my credit score would go from 728 to a near perfect 848 in two years if I made regular credit card payments of $78 toward my account balance of about $1,800 each month for two years.
Further, if I just paid off the balance today, my score would only jump to 748, so a whole 100 points less. Something tells me it's better to pay the card off so I wouldn't have to pay the interest, but is there any scenario where it might be a better idea to just pay the minimum for a few years? It seems like entering an unnecessary credit card purgatory. Thanks, Trevor.
Dayana Yochim: That's a good way to put it -- credit card purgatory -- and that's exactly the answer. Financially, it's always a better idea to never pay interest and to pay off that debt right away. I think probably the simulator was thinking, "Oh, look! You're going to have a perfect payment record for the next two years versus an unknown payment record for the next two years," and that's why it probably gave you the bump like that. You could do the same thing -- pay it off now -- and just always pay your bill on time, and likely you will still get pretty high up there.
Alison: 748 is a good-enough score, right?
Alison: So even if that is true...
Dayana: Don't carry debt to improve your credit score.
Alison: Don't do it.