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Don’t Carry Debt To Improve Your Credit Score

Posted By Jim On 05/21/2009 @ 12:40 pm In Credit | 18 Comments

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 [3]). 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 [4], 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 [5] 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 [6])

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[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/dont-carry-debt-to-improve-your-credit-score.html

[3] read what goes into FICO credit score: http://www.bargaineering.com/articles/fico-credit-score.html

[4] credit utilization: http://consumerist.com/5235873/understanding-credit-utilization

[5] build your credit history and score: http://www.bargaineering.com/articles/how-to-build-your-credit-history-with-tradelines.html

[6] publik15: http://www.flickr.com/photos/publik15/3335452887/sizes/m/

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