There’s this pervasive myth going around that paying off your credit card balance in full each month will score you points (literally) with TransUnion, Equifax and Experian. The fact of the matter is that it won’t. And, in fact, you could even be hurting your credit score by purposefully racking up a high balance and then paying it off before incurring a finance charge. Sound crazy? I’ll explain.
Paying off your credit card balance in full is definitely a good thing. The benefits include:
- Not paying any finance charges.
- Reducing the risk of going into debt.
- Avoiding late or delinquent payments (which DO go on your credit report).
- Being a good customer in the eyes of your credit card company.
I added that obnoxious emphasis to the last point because there is the key difference between building credit and building goodwill with your credit card company. Both are important to your credit score, but in different ways.
FICO Factors – How Punctuality Matters
Payment history eats up a whopping 35% of the pie that makes up your credit scoring factors. But the credit reporting bureaus are only concerned about whether you pay the minimum amount on time. They could care less if you overachieve by paying off your credit card in full each month. That’s because the carrying a credit card balance is part of the agreement between you and your credit card company. You’re not breaking any rules by doing so. While incurring finance charges may be less economical on a personal finance level, it is by no means a penalty and is not indicative of your inability or unwillingness to stick to the terms of your contract. It’s merely a money management choice.
Timing Issues and High Balances
In fact, paying off your debt in full each month may even less beneficial than you thought because of the way the credit reporting bureaus pull your information. The second biggest slice of the FICO pie is amount owed, which takes up 30%. This is a measurement of your credit to debt ratio, or how much you owe vs. how much you can borrow. So, if you pay off your credit card balance every month, that ratio should be very low, right? Nearly zero, even. Wrong.
Let’s say that you have a balance of $1,000 on your credit card with a $2,000 limit and you intend to pay it off on the 23rd. Meanwhile, the credit reporting agencies pull your file on the 22nd. Guess what? It’s going to show up as if you had a 50% credit utilization, even though it would’ve been zero if they would’ve pulled the information two days later. This is an extreme example, but having a credit utilization of 30% or more can bring down your score by 10 to 20 points.
Fixing the Credit Ratio Quirk
It’s not all bad news, especially if you really are in a position to pay off your credit card in full each month. If so, that means that you have reasonable income and assets and probably qualify for a credit line increase. And since you’ve been such a great, responsible customer who has never missed a payment, your chances for getting a credit line increase are even higher.
Extending your credit line will directly help your overall credit to debt ratio. But it also may help to start charging less on your credit card as well. Use some of that cash that you were saving for the end of the month and buy things the old fashioned way until you get your average credit utilization well below 30 percent at any given time. In this way, you’ll be attacking the issue from both ends and you can reclaim some of those stray FICO points that you deserve.
Got a tip for cutting down your credit to debt ratio? Share it in the comments!
