How Do Lines of Credit Affect Your Credit Score?
Accounting Corner
FICO and other credit-scoring models take many factors into consideration when calculating your credit score. The length of credit history accounts for 15% of your FICO score. Your payment history is particularly important in the calculation. Always try to make payments on time to improve your credit score. Nearly a third of your credit score is based on your credit utilization. Many people think that a high balance-to-limit ratio on your LOC can hurt your credit score; although scoring models do not consider a LOC when they calculate your revolving utilization, sureties might. Therefore, paying your LOC on time could improve your score, as well as lowering your utilization ratio by paying down credit card debt. When you apply for a line of credit, the lender will typically review your credit reports, which could negatively impact your credit score. Inquiries influence 10% of your FICO score. As long as you are not frequently applying for new credit, seeking a LOC should not have a major impact on your FICO score. Why Not Get a Credit Card? There are advantages to using a LOC instead of a credit card. The main advantage is that a LOC is not considered in your credit utilization ratio, so if you borrow money that you do not intend
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to pay back by the next statement date, a LOC might be a better alternative. Not making payments on a credit card would have a negative impact on your credit score. On the other hand, the draw period on a LOC typically lasts only for a few years, and a credit card does not have a time limit. If you do not hit your borrowing limit, you can make payments with your credit card indefinitely. What About a Term Loan? LOCs are better for short-term capital needs, and term loans are better for long-term investments. Interest rates are usually higher on a LOC than a term loan. A LOC might not ever be used, so banks cannot charge the same rates as they do for a term loan unless the line is used. However, application fees and monthly maintenance fees associated with LOCs are often small compared to the hefty origination fees and pre-determined interest payments with a term loan. LOCs and other forms of bank financing need to be used correctly and managed responsibly to maximize your surety bond capacity. Contractors need to keep their leverage ratios low to maintain their bonding capacity.
