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Minimum vs. lump sum payments: Which builds credit?

Erica Sandberg

February 17, 2015

QHi Erica,

I have almost $300 on a card that has a $500 credit limit and has interest of 21.9 percent. I want to build my credit. Is it better for me to make the minimum payments of $25 and stretch it out or to pay it 100 percent? –Wayne

ADear Wayne,

I'm assuming you have already checked your credit reports for free at AnnualCreditReport.com, made sure there are no errors and disputed any errors you've found. All good? Let's go!

When considering how to build a positive credit history, you have to look at the situation from a lender's perspective. What would they want to see in you, the cardholder?

The answer is this: They want to know you are a guy who uses his card responsibly. Essentially, this means that you can and do charge often, but you also get all payments in on time and keep the balance low.Ask Erica

Right now, you are way above the ideal credit utilization ratio. For credit scoring purposes (most lenders use the FICO scoring system, with numbers ranging from 300 to 850, with 850 as the best), the balance carried over on credit cards needs to be less than 30 percent of the credit line at the least. A zero balance is ideal. That means you should not owe more than $150 on your card. If you owe more than that, you appear to be relying on the account to buy the things you need and want. This is important because credit utilization counts for 30 percent of your FICO score.

I have two simple options for you:

Plan 1

  • Pay the debt down to $150.
  • Suspend all new charges until the debt is deleted.
  • Send the issuer at least the minimum requested payment until the account is paid off. That will take about six months. The issuer will send notice of your payment pattern to the credit reporting agencies, and that information will be factored into your credit scores positively.
  • Once the debt is at zero, use the card again. Choose a regular expense to charge, and instead of paying partially, pay in full each month. Paying on time consistently over time counts for 35 percent of your FICO score.

Plan 2

  • Delete the debt immediately, then skip right into using the card regularly and paying in full each month.

Both plans will result in exactly what you want, which is to prove that you can borrow money like a pro. Based on what you will have added to the credit reports, you'll seem like a man who can manage his account in a way that would cause no lender worry.

Meanwhile, the credit limit you have is low and the APR is high, but you want the reverse. For example, you might want the option to charge a pricey item and pay over a few months if necessary, without paying too much in finance fees. Also, the higher your credit line, the more you can have on your balance without affecting your credit utilization ratio.

Check your credit scores (about $20 for each major credit bureau at MyFICO.com) so you can monitor your progress, then do so again after a year of using one of the above plans. After your score has increased because of your good credit habits, ask your credit issuer to increase the limit and decrease the APR. Chances are it will.

However, you'll want to keep the card you have, even if the terms are not ideal, because length of credit history and types of cards in use are scoring factors for FICO. Simply place an auto debit for a regular charge, such as your gym bill, on the card and maintain a zero balance. This keeps the account active.

You can also add a card once you have a good score. Just be sure to apply for the card you're most likely to get, using your FICO score as a guide. You'll want your score to be above the mid-600s for cards catering to consumers with “good” credit, and above the mid-700s for those with “excellent” credit.

You've got the right idea to want to improve your credit. Great credit improves your chances of lower interest rates, lower insurance rates, better job opportunities and even better apartments. In a few short months, you will be in an ideal position to negotiate with the lenders and landlords in your future.

Got a question for Erica? Send her an email.