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Don’t Carry Debt To Improve Your Credit Score

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Shackles of Debt!One of the biggest misconceptions I hear and read about regarding your credit score is that you need to carry debt to improve your score. Some articles say that you should get a car loan because it’ll boost your credit score. Others will recommend that you leave a little balance on your credit card rather than pay it off in full each month. While all of them are technically correct, those strategies will improve your score, they are financially wrong.

Would you pay $20 for something you can get for $10? Or for free?

The logic behind the technically correct but financially incorrect advice is that your credit score will increase if you show “punctuality of payment in the past,” which accounts for 35% of your score (read what goes into FICO credit score). By taking on debt and paying it off slowly, you get the opportunity to show that you are responsible with credit and that you make your payments on time. However, as we learned in reading about credit utilization, your balance is reported when your statement closes, not after you make your payments.

In other words, if you charge $500 each month and pay it off in full each month, your credit history will always report a balance of $500. The difference is that by paying it off, you pay $0 in interest payments. If you were to carry $500 from month to month, you’d be paying a lot more than $0 and your credit report wouldn’t be any different. See why carrying a balance makes no sense? No one cares if you carry a balance from month to month, they just want to see that you’re capable of paying off what you owe on a timely basis.

You’re overpaying for something you can get for much less. The reality is that you can charge small amounts, ~$50 a month, pay it off in its entirety, and achieve the same results as carrying a debt. The best way to build your credit history and score is by consistently making payments on two tradelines for twenty-four consecutive months. Charging $50 to a card and then paying it off is generally enough.

Are there other credit score and history related myths that you know of that I should address?

(Photo: publik15)

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18 Responses to “Don’t Carry Debt To Improve Your Credit Score”

  1. Nathan says:

    What a fantastic, totally common sense article! Why pay interest when you can just pay off your balance and still get the benefits to your credit score?

    Here’s a question though: do you have to wait until you get your cc statement before paying off that balance? I like to put a few regular monthly charges on my cc, and then pay it off in full as soon as possible (I don’t like the idea of carrying a balance between months while I wait for my CC statement to arrive!). Am I totally negating the benefit to my credit score by doing this, or does it still count?

    • Jim says:

      As long as the statement you get in the mail as a payment due, then it still counts because that’s the amount that gets reported. So, if your statement period closes on the 20th, you pay for it on the 21st. If you pay for it before the 20th, then you do negate the benefit because then your balance is reported as $0.

  2. CuriousAG says:

    Short and simple yet valueable :)

    I always make sure to be particular about two of the things you mentioned Jim:

    1) pay in full before payment due date
    2) keeping the overall balance low

  3. carla says:

    Good advice all around. Keeping your balance low (or whatever you can manager) and paying it off in full is the best way indeed.

  4. Robert says:

    Great article. I needed this because I read on Lifehacker that you shouldn’t pay off your balance entirely every month to improve your score.

    Also, since I do have a discover card now with 0% interest (for 6 months)should I go ahead and pay off monthly balances or partially? Or am I wrong in my assumption and my score will be the same either way?

    Love your site btw.

    • Andrew says:

      Either one is fine; just don’t make any new charges, or they will accrue interest from the date you charged them, and payments will go to the 0% balance. This particular shenanigan (is there even a singular of that word) is one of the things the new credit card reform bill outlaws.

  5. Kathryn says:

    See, this is what had me confounded with the Liz Weston book I won from the show. It kept saying to take out a small loan to boost your score but it just debt make any “cents sense” to me.

  6. eric says:

    Hmm…I think the myth I hear most often is about canceling credit cards. Although it may jar with common sense, canceling your accounts often lowers your score because you lose your credit limits and possible long history with them. So I think it’s better to leave the account and cut up the card instead if you rather not use it.

  7. Matt Jabs says:

    Excellent advice which I will most likely follow once I get the old balance paid off within the next 5 months here…CAN’T WAIT!

    Here’s my question. Do you have any knowledge, or what is your opinion, pertaining to whether people who employ this method (use CC but pay it off each month) spend more because swiping the plastic is “just too easy”?

    I have an opinion but would like to hear yours.

  8. thomas says:

    Yeah, I never really thought the “pay over time” method really worked. Pretty sure that this was some “advice” from credit issuers or the credit agencies. They are the Hallmark of the financial world.

  9. oliver says:

    Your article is an eye opener but one other thing I thought was always true was that your credit score takes in account for credit utilization. Most credit company will increase your credit limit unless they feel that you need higher amount and that you do carry some balance for a little while so that they can make some money off of you. Now a days if you don’t carry a balance and just keeping paying off they actually start lowering your credit limit is that true ?

    Do you have any information that states otherwise on increasing credit limit so that your utilization ratio goes up ?

    Thanks

  10. Patrick says:

    I never understood anybody who said that it’s good to carry balance on your credit cards. I use credits cards, but I pay them off immediately and mostly to get rewards from them. Great article as usual Jim.

  11. That One Caveman says:

    I shouldn’t be surprised that people would actually do this, but I still am. Except for the 0% balances I pay off over time, I pay my credit card in full every month. I couldn’t imagine using credit cards to “finance my credit score”. What a bad idea!

  12. labelcd6 says:

    The last thing I care about is my credit score. That may sound ignorant, but I care much more about having zero debt, having a fully-funded emergency fund, and saving for retirement.

    If those things don’t show that I’m credit-worthy, then I don’t care about being credit-worthy.

    • Jim says:

      In the spectrum of “good things” for you, having zero debt, a fully funded emergency fund, and saving for retirement are clearly better. However, nothing stops you from having both. Get a credit card and charge your groceries to it because things like insurance will use your credit score to adjust your premiums. Lower premiums means more for your emergency fund, retirement, or general savings.

      I say that because you sound responsible, getting into CC debt isn’t going to help savings no matter what you save on your insurance premiums!

  13. Andy Jolls says:

    Jim, very nice post. I sometimes recommend a car loan – for expats as an example – to build credit. But the other thing I recommend for young people is a small personal loan for say $500. Sure, I get your argument that it’s financially wrong, it depends how quickly someone needs credit. I absolutely agree that it never makes sense to carry a balance on cc’s. That’s FUD from payday lenders and the like.

  14. Jack says:

    Wonderful article!

    Here’s a way to help your credit score that is seldom written about…………..

    The difference between carrying 75-80% balance to available credit vs. 0-15% balance to availabe credit on your credit cards can amount to as much as a 30-40 point reduction in your score for THAT month. If you go over the limit, I’ve seen it reduce my score as much as 60 points.

    So for the best continuing score, I stay under 15% of my credit card credit limits.

    This does not mean you can’t charge more than 15% of your available credit limits. I often find myself having charged 80-90%, but THERE IS A STRATEGY so it does NOT hurt your score.

    After watching my reports for over two years, it appears the credit card companies report my balances (probably yours too) to the Credit Reporting Bureaus (CRB’s) on the LAST day of the month. Whatever your balances is with them on the last day of THEIR month is what they report as your balance to the CRB’s – which the CRB’s use to determine your debt/credit utilization ratio.

    So, pay down your balance to below 15% of your available credit by the 26th of the month so the credit card companies have time to get your payment in their computer. Stop charging until about the 6th of the next month to give yourself a little time cushion.

    In other words, charge between the 6th and 26th, pay it down before the last day of the month, take a 10 day break and then start charging again if you need. Same strategy every month – it’s never failed me.

    Learn the game – play to win!

    Hope this helps someone.


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