American consumers have often heard that carrying at least a small balance from month-to-month on credit cards is good for their credit score. Credit Score Alert: That rumor isn’t exactly true. But people have been inundated with these myths in the credit world. So what’s the truth behind this story? The truth is that paying on time and paying off old balances from a separate credit card (if applying for a new one), will benefit your needs in the long run.
Paying what is owed is the most economical way because it allows consumers to avoid interest and severe penalties once they decide to consolidate all debts onto a single, zero-percent interest rate credit card if a person desires to take that route. Anyone who doesn’t pay their credit card bill in full and yet decides to carry a balance is not helping their score; they’re paying more interest. FICO (Fair Isaac Corporation), which produces the most widely used credit score system in the U.S., does not award extra points when cardholders carry a balance on a monthly basis, and neither will VantageScore, FICO’s competitor.
“You’re not rewarded for carrying credit card debt,” says John Ulzheimer, a nationally recognized credit expert who previously worked for FICO, Equifax and Credit.com. Ulzheimer said a person is “actually rewarded for lower balances and paying in full each month,” Ulzheimer explained in an email sent to Newsblaze.com.
Here is what consumers need to know about managing credit card payments to protect their credit and steadily increase their credit score.
When Credit Card Balances Impact Credit Scores
Financial experts will mostly say that carrying a credit card balance can be costly especially if the person is using a credit card with a high APR (Annual Percentage Rate). Paying the complete credit card balance can be a clever move to make. Yet those who pile up debt without knowing where they’ll get the funds to pay it off down the line, will be submerged too deep, unable to completely pay off what is owed.
An important factor that affects FICO score is payment history, which, in essence, accounts for 30-35% of the score. If a person makes at least one credit card payment late, the result is likely to affect the credit score negatively. Late payments, over time, can possibly cause more damage, and late payments reported to credit bureaus can remain as a negative item on the score.
Using Too Much Available Credit?
What also makes up the FICO score is the amount owed in relation to total credit limit. FICO also tracks credit utilization, making up 30% of the score. People who exceed their credit limits are considered “too risky” based on the algorithms that determine credit scores. Credit experts and the Consumer Financial Protection Bureau (CFPB), have said consumers need to keep their total utilization below 30% to avoid a negative impact on credit score. For example, a person with a credit limit of $5000 – should not charge over $1500-$2000 on their credit card.
After following this roadmap for a while, keeping the balance at the limit where it should be, and paying monthly balances, apply for a $10,000 limit, and don’t charge over $3000 on the $10,000 limit, unless it is an emergency, and more is needed to spend.
Leaving a Small Balance On Credit Card
To keep total utilization below 30%, try using that same ratio on each card. But here is where things get “tricky” – if a consumer carries the bulk of their debt on a single credit card, or carries significantly less with no balance on the other cards, then the high utilization on the card that is used the most could also lower the credit score.
Transferring Credit Card Balance: How Much Does it Affect Credit Scores?
The answer to this question is, it depends. By switching outstanding debt on one credit card to another card – generally a new one – is a balance transfer to consolidate debt. Transferable credit card balances are used by consumers who seek to move the amount they owe from one card to another with a significantly lower promotional interest rate and better benefits. Benefits may be a rewards program to earn cash back or points for everyday spending.
Most credit card companies usually waive balance transfer fees (ranging from 3%-5% of the transfer amount) to urge consumers to accept the offers. Transferring credit card balance impacts credit scores in different ways. While some transfers may be positive; others are negative if violating the payment agreements. For example, hard credit checks will hurt the score, particularly when closing old accounts.
Many companies will offer a promotional or introductory period of “six to approximately 18 months” with no interest charged on the transferred sum. But the challenge is inherent in the written contract. Transferring a balance means carrying a monthly balance, and by carrying a monthly balance ( even one with a 0% interest rate) still requires making on-time payments of at least the minimum due on the transfer and for any new purchases.
The key to reaping the harvest early is to make payments on-time. Otherwise losing the credit card introductory APR on the transferred balances along with the grace period, and subsequently incurring high-interest charges including the potential penalty of the APR on new purchases.
A person should notice a positive impact on their credit score by transferring a balance to a single new card and taking action to reduce the debt balance on the previous card(s). Still, the downside to it all, is that if a person continues to open new credit cards and transfers any balances their credit score will take a deep dive, meaning their credit score falls. With thorough research, savvy consumers can take advantage of these incentives to avoid high interest rates while paying down the larger debt that was transferred onto the new credit card.
This video explains the step-by-step of credit card balances:
Other Situations Where Carrying a Balance Doesn’t Work Well
So far, the details in this story have shown how carrying a balance can affect credit score in both the short-term and the long-term, but there are many other reasons to avoid carrying a balance on a credit card.
Credit cards with the most perks, including “travel rewards credit cards” often charge the highest APRs – to compensate for their benefits. This creates a dilemma for consumers pursuing rewards who may overspend and wind up carrying a balance, which, in essence, means the interest they are required to pay eliminates the value of all the rewards earned.
Keep in mind the average credit card APR at the end of Q4 2021 is 16.44%. Simultaneously, most rewards and travel credit cards cap the earnings in the single digits, ranging from 1% to 6% of the purchase price.
Let’s say the cardholder transfers the bonus points to an airline to cover pricey business class flights or other luxury travel. They will be hard-pressed to get value anywhere within the range of the amount spent paying the interest charges on the credit card bill.
At What Point Does Paying Off Credit Card Balances Increase Credit Score?
Is that really possible? Yes, maybe, but only under certain conditions. First, a person has to follow the requirements to reap the benefits. For instance, if the credit card holder makes the minimum payment before the end of the statement cycle, positive marks will appear on their credit score for making on-time payments. Whenever a card is paid off, the credit utilization on the report should increase soon; If somehow it doesn’t, dispute the problem with the credit bureaus.
Rotate Credit Cards
Another good strategy to keep credit card balances low is to use ‘one card at a time.’ Be sure to keep a small amount on the card that is regularly used, and if you want to, keep a zero balance on the other card, so that potential creditors can have positive information to report to credit agencies. This isn’t a bulletproof way to deal with multiple cards but it is better than opening too many new credit card accounts. Overall, nothing can beat paying off debt or making payments every single month to fulfill obligations to lenders that will eventually help consumers build credit.
Should Consumers Depend on Credit Cards?
Tracking spending and using a monthly budget are more beneficial for people who regularly charge more than they can afford to pay back. This strategy of tracking spending doesn’t lean too heavily on credit and the resulting benefits will help avoid paying high interest on every purchase made on the credit card. A better option is to spend less than monthly earnings. This avoids increasing debt and allows a focus on reducing it.
How to Benefit Paying Off Large Purchases
As should be obvious at this point, credit cards don’t work too effectively as short-term loans even though plastic money is convenient. The interest rates are too high.
Are there better options for loans to offset high interest rates charged by credit cards?
Sometimes there is a need to make purchases that exceed available cash and could not by paid off in several months. For instance, multiple home appliances, home repairs, or medical bills. To handle this, there is a need to borrow money.
Rather than putting these things on a credit card, a better option is to apply for a personal loan with a much lower APR. Personal loans offer low fixed interest rates that come with a fixed monthly payment and a fixed repayment timeline, whereas credit cards have much higher variable rates subject to rise over time.
Using a credit card for such purchases mixes long-term and short-term debt, and furthermore it risks damage to credit score, which causes more pressure on the consumer every month.
Credit Cards Offering Limited 0% APR
While considering financing a large purchase the best route to use a credit card is to use a card offering 0% APR on purchases for a limited time. Credit cards with limited 0% non-interest allow the person to avoid interest on purchases for a limited time ranging from six months up to two years. Just remember that the interest rate will reset to the regular variable rate after the introductory offer expires. The best interest-free APR cards may earn rewards on spending, thus making the non-interest APR cards a better choice to score points. They also ensure larger purchases can be paid off within a relatively shorter time frame.
What matters most is this: It doesn’t always matter too much whether you are a pay-in-full person or carry a balance, the most important thing to understand is how financial habits affect the credit score. Remember to use credit responsibly and pay attention to credit utilization and spending habits. And don’t forget to pay on time. Life in the credit game will help consumers go a long way to buy what they need without paying upfront.
Now that you know about this credit score alert, don’t say you haven’t been told. Don’t pay extra-high interest rates to achieve good credit because it doesn’t improve credit scores. Become educated and build a higher credit score step-by-step.
Newsblaze Business Reporter Clarence Walker can be reached at: [email protected]
For more information on credit scores and other questions, go here: Credit Reports and Scores | USAGov