Credit scores are crucial in our lives, yet they are often shrouded in mystery and misconceptions. Many people get confused by misinformation, leading to unnecessary anxiety and bad decisions.
What seems most prevalent are myths surrounding credit cards and credit scores. Throughout this post, we'll debunk some of these myths so you can confidently manage and improve your credit.
Credit Score Myth:
I pulled this question from a Reddit board, and as you can see, even the folks giving advice were spreading the myth that keeping a balance on your credit card is good for your credit score.
Credit Score Fact:
Maintaining a credit card balance close to $0 helps your credit score.
This post will explain why.
What is a Credit Card Balance?
A credit card balance is the amount of credit you've used on your card, including charges made, balances transferred, and cash advances (like ATM withdrawals).
What does it mean to carry a balance on a credit card?
Carrying a balance on a credit card means not paying off the credit card bill in full before the due date.
What is a Credit Score?
A credit score predicts how likely you are to pay a loan back on time based on information from your credit reports.
Credit Score Formula
What is a Credit Utilization Ratio?
Your credit utilization ratio, generally expressed as a percentage, represents the amount of revolving credit you're using divided by the total credit available to you.
Let's say you have $1,000 of total credit available and you have a $200 balance, this means you have a 20% credit utilization rate.
What is the Best Credit Utilization Ratio?
Once again, this is another myth perpetuated even by the mainstream media. No, you should not believe that a 30% credit utilization rate is good.
I discussed this on a past episode of the Modern Husbands Podcast with Rod Griffin, Senior Director of Public Education and Advocacy for Experian.
The best credit utilization ratio is close to 0%.
In fact, when I earned a perfect FICO 8 credit score, it was paying all of my credit card balances in full every day that put me over the top.
What Happens When I Carry a Credit Card Balance Before the Payment is Due?
"The higher your credit card balances, the more your credit score will drop."
What Happens When I Carry a Credit Card Balance After the Payment is Due?
High Interest Charges
Credit cards often carry high interest rates. If you leave a balance, you'll incur interest charges, which can quickly accumulate and make your debt more expensive.
Negative Impact on Credit Score
High credit utilization can lower your credit score. Maintaining a balance increases this ratio, potentially harming your creditworthiness.
Increased Debt Load
Allowing balances to accumulate means you are taking on more debt. Over time, this can lead to a significant financial burden that's difficult to pay off.
Financial Stress
Carrying credit card debt can create anxiety and stress about your financial situation, impacting your overall well-being.
Lost Financial Opportunities
Money spent on paying interest could be better used for savings, investments, or other financial goals. Paying off your balance frees up funds for other purposes.
Risk of Falling into a Debt Cycle
Regularly leaving a balance can lead to a debt cycle in which you constantly pay off interest and never fully clear the principal amount owed.
Impact on Loan Applications
A high outstanding credit card balance can negatively impact your ability to secure other loans, such as a mortgage or car loan, because lenders may see you as a higher risk.
Fees and Penalties
Carrying a balance may result in additional fees, such as late payment or over-limit fees, in addition to interest, further increasing your debt.
Reduced Financial Flexibility
With a portion of your income going towards credit card payments, you have less flexibility to cover unexpected expenses or emergencies.
Reduced Credit Limit Availability
Having a balance reduces the amount of available credit, which can be problematic if you need to use your card for significant or unexpected expenses.
Learn More
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