Consultant’s Corner: Maximizing Your Credit Score with a Balance Transfer

Q. How does shifting debt from one credit card to another and reducing the credit utilization impact your overall credit profile and credit score? Will it increase, decrease, or stay the same?

Credit card utilization is one of the most important factors credit scoring models use to calculate one’s credit score. Generally speaking, there is a strong correlation between credit card utilization rates and credit scores. Assuming other factors remain equal, individuals with a lower utilization rate have a higher credit score, and vice versa, but various factors beyond credit card utilization rate can impact the credit score. For example, if you increase your total credit (say, by opening a new account with a higher limit while keeping an older account with a lower limit open), that will have an impact on your credit score.

To develop a better understanding of how credit card utilization rates and balance transfers can affect your credit score, consider this advice from Experian:

“Credit scores consider both your total balance-to-limit ratio, or utilization rate, and your balances as compared to the limits on individual accounts…

If you have a high balance-to-limit ratio on one card, that negative can be significantly off-set by having a low overall utilization rate. That is why we caution against closing unused cards if your scores are low and eliminating that open credit line might increase your total utilization ratio.”

Balance Transfers

The idea of a balance transfer can be appealing when you have debt on a credit card with a high interest rate. If you do it responsibly, a balance transfer can improve your credit score by reducing your debt, but the calculation be complicated with different things to look at in the short term and in the long term.

Factors that could impact your credit score include:

• How much money you move over in a balance transfer
• Your new total available credit
• Whether your transfer completely pays off the account
• Whether you close a credit card account
• Whether you pay off the balance after the transfer

Since the best way to improve your credit score is to pay back your debts, a balance transfer to a lower interest card can help by not only increasing your credit utilization rate, but also by helping you pay off the balance more quickly.

Downsides of Balance Transfers

Another factor in your credit score is the age of your credit accounts. The longer your accounts have been open, the higher your score will be, based on looking at the age of your oldest account as well as the average age of your various accounts. If you shift balances between existing accounts, there should be little or no impact on your credit score, but if you open a new account your score will decrease as the new card brings down the average age of your accounts. Closing your other account would have further negative impact by eliminating an older account that props up your score.

Your credit score is also affected by credit inquiries. Whenever you apply for a new credit card, that counts as an inquiry, and will have a slight negative effect on your score, staying on your report for two years. If you make many different applications, that will both reduce your score and make it less likely for your application to be approved.

So while a balance transfer will improve your credit utilization rate and make it easier to pay down your total debt in the long term, in the short term there might be some decreases to your score as the average age of your accounts decreases and new inquiries knock your score down temporarily.