How Sharing Revolving Debt Can Save Investors Thousands

The two largest components in a FICO credit score are Past Delinquencies (35%) and the Revolving Debt Ratio (30%). Last month, we learned how delinquencies can significantly lower a credit score and to what degree. Moving on to the revolving debt ratio, we will discover how we can use credit cards to share debt and boost our scores.

If you want to improve your credit score, the revolving debt ratio is an important tool and an area to rack up points and creditworthiness. The best way to maximize your credit is to have three to five credit cards. The reason for having multiple cards is simple, debt sharing. Shared debt lowers the ratio and can increase a credit score. The higher your debt utilization the more interest you will have to pay and the lower your credit score will be. This combination can considerably damage not only mortgage loans, but auto loans as well. I will elaborate on this topic later in the article.

Now, let’s look at an example of how sharing debt can lower a debt ratio. Samantha has $5,000 in total debt and she has two credit cards with different limits. The first card has a $5,000 limit and the second has a $10,000 one. Samantha is unable to completely pay the money owed on the first card. The best way she can maximize her credit is to allot two thirds of the total debt ($3,333) to the $10,000 limit card and one third ($1,667) to the lower limit card. Instead of having a maxed out card and an inactive one, she has $15,000 in credit limits and $5,000 in debt which translates to 33% debt utilization. If Samantha only had the $5,000 limit card, she would be 100% in debt. Even if she could pay off the majority of the debt, she would have zero available credit reporting to the credit bureaus and her credit score would suffer along with the interest rates on her next loan. For those who invest in multiple properties, getting that extra credit card to share the debt and lower the ratio can be a huge benefit, especially if you are unable to completely pay off a debt.

If you can pay your balances in full each month and prefer to use only one card, it is still better to have a back up card, using it only once every six months for small purchases. As long as the card does not become inactive, it will continue reporting to the credit bureaus and help increase creditworthiness. Inactive accounts do not benefit a low debt ratio or the average credit file age and will also lower a credit score. Consequently, you want to use your credit cards at least once every six months to keep them reporting to the bureaus as an active account.

If you do have an inactive account, do not cancel the credit card. This, I call credit card suicide. Unless the card is very young, canceling it will increase your debt ratio and decrease the average age of your credit file as well as your credit score. A lower credit score can be detrimental to loans causing high interest rates. We learned in last month’s issue that a high interest rate could cost hundreds of thousands of dollars over the life of a mortgage loan, but what about for insurance rates? Yes, insurance companies look at a consumer’s credit score to help determine rates.

Look at the comparison below detailing the potential monthly auto insurance rates for 2002 Honda Accord for a 35-year old male. With great credit (a score between 720 and 800), he would be paying $76 a month, but poor credit (a score 600 or below) could cost him $156 more each month, which is $1,872 more for auto insurance each year!

A great credit score is the key to financial health and security. By paying your loan and insurance payments before the closing date, you are helping your creditworthiness to inch forward. To further increase a credit score, apply for more than one credit card in order to share debt and use each of them at least once every six months. If you do happen to have loan delinquencies (see last months issue), a low revolving debt ratio could help save your score and your wallet.

Brought to you by Financial Solution Services' Research & Development team