Can reducing my credit card debt actually lower my credit score?
Most lenders use an automated credit scoring system to help determine your creditworthiness. The higher your credit score, the more creditworthy you appear. One of the factors built into credit scoring systems is your credit card balance-to-limit ratio (the amount of debt you owe compared to your total credit limit for all cards). Lenders like to see ratios indicating you’re indebted for balances approximating no more than 30% of your total limit.
Generally, if your balance-to-limit ratio is higher than that, then reducing your debt will improve your credit score. But how you reduce your debt can make a difference. You may have heard that you should consolidate several credit card balances on one card with a low interest rate, then close the paid (usually higher-rate) accounts. Doing so, the claim goes, not only minimizes the risk that you’ll “dig the hole” of indebtedness even deeper, it also reduces your exposure to identity theft through the fraudulent use of inactive open lines of credit.
But if you do this, you could:
• Lower your total credit limit available without lowering your total debt, thus raising your balance-to-limit ratio–and potentially lowering your credit score in the process
• Make your credit history appear shorter by canceling accounts you have had open longest–and a shorter credit history also may lower your credit score
While it makes sense to transfer balances subject to high interest rates to accounts with lower rates (and then concentrate on paying
down what you owe), consider waiting to close the paid accounts. Keeping them open may actually improve your credit score by lowering your balance-to-limit ratio (since you’ll have the same amount of debt, but a higher total credit limit) while maintaining the longevity of your credit rating.
