by Matt Frankel, CFP | Dec. 10, 2018
Generally speaking, building a strong credit score is a marathon, not a sprint. In other words, the most surefire way to get excellent credit is by demonstrating responsible financial behavior over a long period of time.
Having said that, there are some tricks you may be able to use in order to boost your credit score in a relatively short amount of time. If you have a significant amount of credit card debt, here's one way that you may be able to get a quick credit score boost, even if you can't afford to pay off your balances just yet.
There are five weighted categories of information that make up your FICO® Score, and the second heaviest-weighted one is "amounts owed." This category accounts for 30% of your FICO® Score and includes information about how much you owe on your credit cards.
For a little more color, the "amounts owed" category doesn't put too much emphasis on the actual dollar amounts you owe on your credit cards. In other words, $10,000 worth of credit card debt isn't necessarily better than $1,000.
Instead, the more important factor is how much you owe on your credit cards relative to your available credit. This is known as your credit utilization ratio. For example, if you have a $5,000 credit limit and a $1,000 balance, your utilization ratio is 20%.
Lower is better, and experts generally suggest that consumers should strive to keep their utilization ratio under 30%. This applies to your individual credit accounts, as well as to your overall available credit. For context, the average consumer with a FICO® Score above 800, which is widely considered to be excellent credit, has a credit utilization ratio of just 4%.
The takeaway is that a high utilization ratio can lower your FICO® Score, while a low utilization ratio can be a positive influence on your score.
To be thorough, the "amounts owed" category doesn't only consider credit card and other revolving credit line debt. It also considers your installment loans such as mortgages and auto loans or more specifically, how much you still owe on these loans relative to your available balances.
While we don't know the precise FICO formula, one thing experts generally agree on is that installment loans tend to be considered more favorably than credit card debt. There are a few possible reasons. For one thing, installment loans are typically considered to be a more "responsible" form of debt. Also, while it's considered to be a sign of financial trouble to use say, 90% of your credit cards, there's nothing wrong with owing 90% of your original mortgage balance.
In a nutshell, all other things being equal, installment loan debt is less likely to cause your FICO® Score to drop than revolving debt like credit cards.
Having said all of that, one smart move could be using a personal loan (installment loan) to consolidate your credit card debt (revolving).
Over the past several years, the personal loan industry has exploded. Many companies, both new and long-established, are now offering streamlined, innovative personal loan products. Just to name a few, major personal lenders include Lending Club, Marcus by Goldman Sachs, Prosper, SoFi, Citi, and many more.
It's important to mention that consolidating your credit card debt with a personal loan isn't likely to be the best money-saving option. For example, if you have a good credit score, you could potentially obtain a balance-transfer credit card with a 0% APR for as long as 21 months. Meanwhile, the lowest interest rate that the average "excellent credit" borrower is offered on a personal loan is more than 7.5%. Personal loans tend to come with rather high interest rates for consumers with below-average credit scores, so if you're in that category you may want to compare the interest rates offered by credit card products available to consumers with bad credit before proceeding with a personal loan.
In other words, if saving money is the most important factor to you, the balance transfer route is probably better. If you want to maximize your credit score as fast as possible, eliminating your credit card debt with a personal loan could do the trick.
To be clear, since the FICO credit scoring formula is largely confidential, there's no guarantee that this strategy will work for you, or that it will boost your score by any certain amount.
However, expert interpretations of the FICO scoring methodology certainly support the principle that installment debt is generally better than revolving debt. In addition, I can tell you from personal experience that this strategy can significantly boost your score.
In the process of buying and furnishing our current home a few years ago, combined with the expenses associated with our new baby that came along at the same time, my wife and I built up quite a bit of credit card debt. It wasn't too excessive -- about 20% of my total credit limit at the time -- but it was clearly weighing on my credit score.
So, I decided to obtain a personal loan (I used Marcus by Goldman Sachs) to pay off the credit card balances and reduce my interest rate. To my surprise, after the new loan appeared on my credit report and the credit card balances were gradually updated to $0 over the next month or so, my FICO® Score shot up by more than 40 points. There were no other major changes, so it was pretty clear that it was due to shifting the nature of my debt from revolving to installment.
Again, there's no guarantee that you'll experience similar results. However, it's fair to say that if you have significant credit card debt, a personal loan could not only help boost your credit score but could potentially save you hundreds or even thousands of dollars in interest.
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