Will Paying Off My Credit Cards Increase My Credit Score?

According to myFICO, amounts owed, or credit utilization, accounts for about 30 percent of your credit score. The higher it is, the more it negatively affects your score. It only makes sense that reducing your credit card balances will help increase your credit score, but there is no hard rule for how much of an increase it will have.

Credit Scores

Your credit score is made up of several factors, including payment history, credit utilization, length of your credit history, new credit and types of credit on your history. Credit reporting agencies weigh these factors to determine your credit score. Equifax, TransUnion and Experian, the three main credit reporting agencies, each create their own score based on the information that appears on their individual reports. The degree of importance given to each factor varies from agency to agency. That is why credit scores vary from agency to agency, even if their reports all reflect the same information.

Credit Utilization

The two factors with the most weight are payment history and credit utilization. While figuring payment history is simple --- whether you make your payments on time and as agreed --- credit utilization is not. It takes into account how many credit lines you are using, what kind of credit they are, along with how much you owe and how that figure compares to your maximum credit limit. The amount you owe as a percentage of the maximum you can borrow is your credit utilization ratio. This percentage typically focuses on your revolving account balances, or credit card accounts.

Utilization Ratio

It is easy to figure your ratio and the affect that paying down balances will have on it. Add the total balances for all of your credit cards and divide it by the total of all your credit card limits. The resulting number is your credit utilization ratio. For example, you have three cards with a total balance of $3,000 and your total credit limit is $10,000; your ratio is 30 percent. Paying down on any of those three cards will drop your ratio.

Expert Insight

Experts seem to disagree on the exact percentage your credit utilization should be --- there are recommendations of everywhere from zero to as high as 75 percent --- but the majority seems to fall in the range of 30 to 50 percent. Yet, the myFICO website operated by the company that provides the credit scoring model used by Equifax recommends a credit utilization of below 50 percent.

Effects

While paying down your credit cards will lower your ratio, the impact it has on raising your score is a case of diminishing returns. You will see a significant improvement within a few months of paying down your ratio to that 30 to 50 percent range. However, once your balance drops below that range, paying the balance down further will have less and less impact on your score.

Warning

Closing paid off credit cards can counteract the boost from paying them down. Let's say you have three cards totaling $6,000 and a credit limit of $10,000. You pay off, then close, the one you owe $3000 on that has a $5,000 limit. Your ratio stays at 60 percent instead of dropping it to 30 percent because you drop your maximum credit limit to $5,000.