Even if you always pay your statements in full and don’t carry balances on your credit cards, your credit report may still show high credit utilization! How come?
The reason for this lays in the way the credit card companies report to the credit bureaus. On closing date two things happen simultaneously:
- A statement containing your current balance is issued and sent to you.
- That same balance is reported to the credit bureaus.
The credit bureaus have no clue whether you pay your statements in full or just the minimum payment. They’re only interested in the reported balance, which will appear on your credit report.
The reported balance plays an important role in your credit standing and may even determine whether your application for credit is approved or denied:
- The credit bureaus use it to calculate your credit utilization ratio (Revolving Utilization), which accounts to 30% of your FICO score. Utilization above 35% lowers your credit score and adversely affects your chances of approval.
- Potential lenders use it to calculate your debt-to-income ratio, which is another factor (in addition to credit scores) in their lending decision.
Say that you have two credit cards, each with a limit of $ 5,000. Let’s also assume that you regularly charge them $5k – $7K per month in total (many people charge their entire monthly expenses for reward points).
Even if you pay your statement in full every month, your credit utilization will be 50% – 70%, and your credit score will take a serious hit. That alone can be a crucial factor in any lending decision, and will certainly get you lesser terms and interest rates!
Now let’s assume that you apply for a mortgage or a car loan. The lender uses that same reported balance to calculate your “debt to income ratio”, which is a crucial factor in the lending decision. By rising that all important debt-to-income ratio beyond the lender’s standards means your application is rejected.
How to force the credit card companies to report a low balance?
Keep track of the “statement date”, “closing date” or “billing date” of each of your credit cards by checking your previous statements or going online. You also need to keep track of what you’ve charged on each card (either manually or by going online).
Once you figure out each card’s statement date and expected balance, simply pay online or send a check for the expected billing amount before the statement date. If you send a check by mail send it at least a week ahead of the expected statement date, so that it will arrive and be processed before the closing date.
You can keep using the cards after you pay. Your statement will show a small balance – only the new items you’ve charged between the date your payment was processed and he closing date.
Does paying credit card before statement has any drawbacks?
Only if you refrain from using the cards from the date you’ve sent the payment until the closing date on a regular basis. In that case your statements will show $0 balance.
While zero balance in itself is not bad and will not lower your credit standing, it doesn’t build credit as well.
Statements with zero balance have the same effect as not using your cards. If you want to improve your credit scores you need to show consistent stream of timely payments, and you need to show some balance (small but greater than $0) for that.
Best practice is to use this technique two or three months prior to applying for credit, certainly before applying for a mortgage of a car loan.
There are no benefits for paying credit card before statement on a regular basis, but if you do – make sure to keep charging the card with small purchases so that the statements don’t show $0 balance for a long period of time.
One important rule to remember
If you get a bill, you MUST pay at least the minimum regardless of whether you reduced the balance earlier in the billing cycle.