I was at the American Bankers Association annual conference last week speaking about credit scoring and consumer confusion on the topic.
I received an interesting question from one of the bankers in the audience about how best to improve credit scores.
His asked, “Is it better to have one credit card completely maxed out or is it better to spread the balance out across several credit cards?”
First off, neither is good for your credit scores. Having only one credit card that is completely maxed out is bad news for your FICO and VantageScore credit scores.
Will spreading out debt improve your credit scores?
The issue is the balance-to-limit ratio, which is an important measurement in both of those credit scores. The higher the ratio the lower your scores will likely be.
So that means spreading the balance out across several credit cards solves that problem?
Wrong. You may not have one credit card completely maxed out but now you have several credit cards each with a balance and that poses other credit score problems.
There are measurements that consider not only the number of revolving accounts with balances but also the number of any type of account with a balance.
It’s rare that a change on a credit report happens in a vacuum.
What that means is even if you take a score improvement action that seems to make sense you could be adversely impacting other score measurements at the same time.
If a consumer moved $10,000 from one credit card and spread it out across 6 credit cards he would likely end up with a lower credit score.
Here’s what happened and here’s what didn’t happen in that scenario.
1. You didn’t reduce your amount of credit card debt by even one penny. Your still in $10,000 of aggregate credit card debt.
2. Your balance-to-limit ratio, in aggregate, is still the same as it was before. If you were 75% “utilized” before you started moving around your balances you’re still 75% utilized after you’re done.
And, if you make the mistake of closing unused cards as part of your balance redistribution exercise then your utilization percentage will be higher than 75%, not good.
3. You increased the number of accounts with a balance by 5.
If your $10,000 balance on the one card was your only balance and you spread that balance across 6 cards, then you went from one account with a balance to 6 accounts with a balance — not good.
4. You increased the number of credit cards with a balance. Remember, this is a separate measurement than the one taken in number 3 above.
So, not only did you increase the number of accounts with balances you also increased the number of credit cards with a balance from one to 6, which is not good.
5. You reduced the balance-to-limit percentage on one credit card.
Congratulations! This is the only good thing that happened when you decided to spread around your balances.
But, the points you’ll gain by doing this are unlikely to net out the points you lost at the same time.
Opening more cards won’t work, either.
If you opened new credit cards in order to have new destinations for bits and pieces of your credit card debt then you just compounded your problems.
1. You just added several new credit card inquiries to your credit reports. Credit card inquiries are among the most problematic.
2. You just added several new accounts to all three of your credit reports. By doing this you’ve just lowered the average age of your accounts.
There’s a measurement in credit scoring models that takes the average age of all of your accounts.
Younger isn’t better than older. The more new accounts you add to your credit reports the more damage you may have done.
The bottom line.
The only truly clean solution to the $10,000 balance dilemma is to pay it down, or off.
John Ulzheimer is the Credit Expert at CreditSesame.com, and a credit blogger at SmartCredit.com, Mint.com, and the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. You can follow John on Twitter here.