The Importance of Credit Card Balances and Active Credit Accounts
Why is your credit card balance important? Does it really matter? Should you use all your credit cards every month? What happens if you skip a month or two?
Knowing your credit card balances and keeping your credit accounts active are important because both are factors when computing your credit score.. If your goal is to increase your credit score, below are some tips concerning your credit card balances and keeping your accounts active.
One of the most frequently asked questions about credit is: Can I raise my credit score by paying off my debt?
The short answer is yes, but there’s a big caveat: You must keep your credit cards active.
Two of the factors that the credit-scoring bureaus consider when assigning credit scores are:
- Your balance-to-limit ratio
- Whether your accounts are active
Your balance-to-limit ratio—Credit-scoring bureaus award higher scores to people who have credit card balances that are no more than 30 percent of their overall limit. If your limit is $10,000, for instance, your balance should never exceed $3,000.
The first step to help students increase their credit score to 720 or above is to maintain a balance no greater than 30 percent of each credit card’s limit. This may seem insignificant but it shows the credit bureaus that you are in control of your spending habits.
30 percent is a great goal, but if you charge no more than 30 percent of your credit limit and pay that amount monthly, that’s even better. Your credit score will soon reflect your financial discipline by rewarding you with a credit score of 720 or above.
You may have heard, “It doesn’t matter how much you charge as long as you pay the full balance monthly.” This is not a true statement. It always matters when your credit card balance exceeds 30 percent of your credit limit. If you want to increase your credit score, know the importance of keeping your credit card balance less than 30 percent of your credit limit.
From a credit-scoring perspective, bureaus look at your credit-card balances as a snap shot in time, which means that if you have a credit card with a $2,500 limit and a $2,000 balance on the day your credit report is pulled, your score will be lower, even if you just sent in a check for $2,000 that simply has not cleared the bank.
When teaching students how to increase their credit score, I stress the importance of never exceeding 30 percent of their credit limit. If possible, I tell them to strive for a zero balance because the closer they can keep their balance to zero, the better!
The second step to help students increase their credit score to 720 or above is to keep their credit cards active. In my webinar, I explain the importance of keeping credit cards active when building and rebuilding credit. They must use their credit cards in order to build a credit history. Otherwise, the credit-scoring bureaus have no way of telling whether you are a responsible borrower.
Think of it this way: Let’s say you own an airplane. Does owning an airplane automatically get you a pilot’s license? No. To get a pilot’s license, you must take classes, demonstrate your ability to take off and land, log the required hours of flight practice, and get the proper certification.
Likewise, owning credit cards is not enough. You must prove you know how to use them wisely. This proof is your credit history because it demonstrates your financial discipline or lack of discipline. Credit-scoring bureaus base your credit score on your most recent credit activity. Therefore, use your credit cards regularly
So how do you keep a low balance on your credit cards while still keeping them active?
Simple. The ideal number of credit cards is between three and five major revolving credit cards. Let’s say you have four. Although you want to pay them off, you know keeping credit cards active will increase your credit score. Here is a strategy for raising your credit score while paying off your debt.
- Identify four bills that have a set monthly payment. For instance, your gym membership, magazine subscription dues, car insurance, and health insurance bills are probably the same amount each month.
- For each of your four credit cards, schedule an auto pay of one of these bills.
- Then, create an auto payment from your checking account to each credit card company. This auto payment should occur two days after the charges appear on your credit cards. For example, schedule your Visa, MasterCard, American Express, and Discover Card auto payments after your gym membership, magazine dues, car insurance, and health insurance bills appear on the statements. Then create another level of auto payments so your checking account pays your credit card balances two days later.
This way you will never pay interest but will keep your credit cards active while paying credit card debt monthly.
So what about other debt like loans? Here’s a tip on how to build credit by getting small loans.
Let’s pretend you are going to buy new furniture. Assume you have enough money to buy the furniture outright, but the goal is to build your credit.
If the bank will report the loan as an “Installment Loan” to all three credit bureaus, it’s a great idea to finance part of the purchase. Then, pay the bill for six months before paying the remaining balance in full.
Let’s assume you finance $5,000 and pay 10 percent as an interest rate. Your monthly payments are $41.66. You pay these for six months before paying the balance in full. During these six months, your interest payments are small. The greatest benefit is a new item appears on your credit report as “Paid in Full” and “In Good Standing.”
If you have any other questions about credit, be sure to post them below.