Welcome to the “2-Minute Money Manager,” a short video feature answering money questions submitted by readers and viewers.
Today’s question is about credit, specifically, whether we need to carry a balance on our credit cards to maintain a healthy credit score.
Watch the following video, and you’ll pick up some valuable info. Or, if you prefer, scroll down to read the full transcript and find out what I said.
You also can learn how to send in a question of your own below.
For more information, check out “The 6 Best Credit Cards This Spring” and “4 Reasons You Should Switch Credit Cards.” You can also go to the search at the top of this page, put in the words “credit cards” and find plenty of information on just about everything relating to this topic.
Got a question of your own to ask? Scroll down past the transcript.
Don’t want to watch? Here’s what I said in the video
Hello, and welcome to your “2-Minute Money Manager.” I’m your host, Stacy Johnson, and this answer is brought to you by Money Talks News, serving up the best in personal finance news and advice since 1991.
Today’s question comes from Cherri:
“I just paid off my last credit card (WOOHOO!!!!), and honestly I don’t plan to ever use credit again unless I ABSOLUTELY have to. Will not carrying any credit card balances have a negative effect on my credit score?”
It’s a myth
There are lots of credit score myths. For example, some think income matters — it doesn’t. Some think getting married affects your credit score — nope.
And another popular myth? That you need to be in debt to get a great score. Not true: My credit score is a perfect 850, and I haven’t carried a balance on my credit card for 30 years.
Fact is, carrying too much debt can hurt your score. Not carrying any doesn’t hurt it.
That being said, showing you’re an active credit consumer does make you look more appealing to credit card companies and can improve your chances of card approval. This much I do: I carry and use several credit cards, and charge thousands monthly for this business and personal use. But I pay off those balances every month and so should you.
In short, it’s not carrying a balance on your credit card that makes you look good to lenders, it’s paying your balance on time, all the time, for long periods of time.
Your credit score, explained
There are lots of different credit scores out there, but by far the most common is the FICO score, from Fair Isaac Corp. And while they won’t tell you exactly how your score is computed, they’re happy to give you the broad strokes.
The No. 1 factor determining your credit score, making up more than one-third of your total, is your payment history: In other words, how you’ve done paying back what you borrowed.
Obviously, in order to make a payment, you have to use your credit cards. If you never use them, you won’t improve your score. In fact, you can hurt your score if your credit card gets canceled for inactivity.
The second-biggest part of your FICO score, responsible for 30%, is called “amounts owed.” As the label implies, this is about much debt you carry in total, but it also has other components.
One part of “amounts owed” is your credit utilization ratio. That’s a fancy term for a simple idea: How much you’ve borrowed compared to how much you could borrow.
For example, if you have a credit card with a $1,000 balance and a $10,000 limit, you’ve utilized 10% of your available credit. That means you’ve got a 10% utilization ratio for that card. Each debt has its own ratio.
You’ll hear this talked about a lot because it’s something you can influence, either by paying down balances or getting a higher credit limit.
Some credit score experts will suggest maintaining a credit utilization ratio of less than 30% for each debt, while others suggest a 10% ratio is better. In any case, the lower the better.
There are other, smaller factors determining FICO scores. The length of your credit history is important, which is why most credit card experts will tell you to keep your credit card accounts open as long as you can, even after they’ve been paid off. Having varying types of credit is also good; in other words, having installment loans, like car and mortgage loans, as well as revolving loans, like credit cards.
“Hard” credit pulls can also hurt your score, so keep credit applications to a minimum, and only apply for credit cards you’re reasonably sure you’ll be approved for.
The bottom line
It’s logical to think that carrying a balance will improve your credit score. Logical, but wrong. Cherri, keep your cards, use your cards, but pay them off every month. That way you’ll keep a great credit score without paying a lick of interest. And that’s just the way we like it.
See you all right here next time!
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The questions I’m likeliest to answer are those that will interest other readers. In other words, don’t ask for super-specific advice that applies only to you. And if I don’t get to your question, promise not to hate me. I do my best, but I get a lot more questions than I have time to answer.
I founded Money Talks News in 1991. I’m a CPA, and have also earned licenses in stocks, commodities, options principal, mutual funds, life insurance, securities supervisor and real estate.
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