Reducing credit card debt ratios affects FICO and Vantage credit scores in unique ways.

The method you choose to shrink balances determines where and when you qualify to borrow money again. Tread carefully and weigh the pros and cons of several different approaches.

Credit card debt settlement hurts credit ratings but offers significant relief.

Credit card debt consolidation loans have a lesser impact on credit ratings as you are just restructuring terms. The same holds true for balance transfers.

Paying down credit card debt helps credit scores the most – if you have the resources. Be careful to weigh the advantages and disadvantages of closing the accounts afterward.

How Reducing Credit Card Debt Affects Credit

Reducing your credit card debt will affect your FICO and Vantage credit score. The direction it moves depends on the method used to shrink what you owe. Nothing comes without a price.

The methods offering the most relief will hurt both ratings more. The options that help your rating the most require the greatest financial sacrifice. There is no free lunch.

Debt Settlement

Do you qualify for debt relief? Using a credit card debt settlement program to reduce the balance owed will always hurt your credit score. The most qualified people are suffering financial hardship, and are already behind on payments. Therefore, a lower rating is meaningless.

In addition, negative credit card debt history erases after 7 years – counting from the date of first delinquency. The clock has already started clicking for people late on payments. They have little to lose and much to gain – a significant reduction in obligations!

Debt settlement hurts credit ratings for people now current on payments in a more impactful way. Therefore, if you want to protect your ability to borrow money in the next 3 to 5 years, consider other options to reduce your obligations.

Debt Consolidation

Personal loans are a popular choice for lower payments. Credit card debt consolidation loans have a mixed impact on your credit score. The amount of money you owe remains the same, so you are not really reducing obligations.

People with above-average qualifications and on-time payments find this alternative most attractive. They often qualify for an approval and protect their ability to borrow money in the future by avoiding delinquency.

Debt consolidation loans are both good and bad for ratings when paying down credit card debt. One score factor helps and two factors hurt. The net effect is different for every person.

  1. The lender logs a hard inquiry at one bureau during the application phase – negative
  2. Approved accounts appear on the consumer report at all three bureaus – negative
  3. Revolving utilization ratio drops after paying down the balance – positive

Paying Down

Paying down credit card debt is the best way to improve your credit score. Of course, it is the most difficult method because it often takes discipline and lots of your own money. Most consumers will see immediate positive movement in two important metrics.

  1. The revolving utilization ratio will drop. See more about this in the section below.
  2. Late payment status codes on your report may update to “paid was delinquent.”

Banks report updated information to the bureaus every thirty days. They cut the update several days after the conclusion of each billing cycle.  You should see an increase in your rating immediately after the Bureau processes the updated payment information. The bureaus calculate credit scores dynamically, using the most recent report.

Any negative payment statuses will age off your consumer report 7 years after the date of first delinquency.

Balance Transfers

Balance transfers from one credit card account to another should not affect your credit score. You are simply moving money from one pocket to another. The amount of money that you owe remains the same. However, there are three possible exceptions.

  1. Opening a new credit card and using a balance transfer check to pay off an existing account could hurt. First, the new bank will log a hard inquiry on your file when evaluating the application. Second, the new bank will report the new trade line. Both harm your qualifications temporarily.
  2. Using a balance transfer to pay off credit card account where you are behind in payments resets the status to current was delinquent. This will quickly improve qualifications. However, you must pay the new account on time to realize the benefit.
  3. Taking advantage of a zero percent interest rate balance transfer could slow the accumulation of interest. Over time, this could lead to smaller amounts owed. Smaller amounts owed tend to improve qualifications.

How Credit Card Debt Ratios Affects Credit

Reducing the credit card debt ratio affects your FICO and Vantage credit score. The percentage is an important interim factor in both risk ratings. It measures your degree of financial distress and flexibility.

  1. High ratios occur when balances are close to the limit and hurt qualifications.
  2. Low ratios occur when balances are far from the limit and help qualifications.

Reducing amounts owed does not guarantee that the utilization ratio will improve. The fraction has two components a numerator (balance) and the denominator (limit).

Utilization Ratio

The credit card utilization ratio influences credit scores and has a simple calculation. It considers your behavior in total, and not on a per card basis.

total account balances/total account limits

  1. The consumer controls the numerator in this equation. You calculate the balance by adding all purchases, late fees, and accrued interest charges. Then you subtract the payment.
  2. The banks determine the denominator in this equation. The account limit is a measure of the banks’ confidence in your behavior. They consider internal and external data when making this evaluation.

Paying in full every month does not necessarily move the revolving utilization ratio to zero. If you continue making purchases the bank will still report a positive balance. You must stop making purchases altogether to move the utilization ratio lower.

Paying early or multiple times per month are great ways to improve utilization!

Closing Accounts

You may have read elsewhere that closing credit cards is bad for your credit score. This is applicable advice for many people, but not everybody.

Closing credit cards raises the revolving utilization ratio and can lower the average age of accounts. Both are important factors in risk ratings. However, only the first factor really matters.

  1. Utilization ratio rises because the limit on the closed account is no longer part of the calculation. This effect is real. Aim to keep the percentage below 30% by lowering balances, requesting a limit increase on an existing card, or replacing the closed account with a new one with better terms.
  2. The average age of all accounts could drop after closing a credit card. Any positive history remains on your report for 10 years. Negative history erases after 7 years counting from the date of first delinquency. Therefore, this impact is negligible at the outset.

Closing credit cards actually helps credit ratings for people who need to control spending. People spend less when they have to reach into their wallet to pay cash. They also avoid late fees, sky-high interest charges, and black marks on their consumer report.

Cut up the plastic if it keeps you out of trouble!