What Consumers Should Know About Credit Card Balances

​"Pay it off every month!” That is what your parents always told you when you first started using credit cards. “Pay it off every month and you won’t get bad credit.” If your goal is to save money on paying interest then this might be the ideal approach. However, this won’t keep you from getting bad credit. If your goal is to improve your credit score then you may actually be hurting your credit rating by paying it all off every month.

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Many lenders use your FICO credit score to determine your eligibility for credit. Credit scoring involves a complicated algorithm that incorporates your usage of existing credit lines, and how you pay these existing credit lines back. Whereas credit utilization is a metric that divides your credit card balance by your credit card limit to determine what percentage of your limit you are carrying on the card. In other words, you may use your credit card every month, and pay it off every month, and think that you are creating a great credit rating. But if the credit raters look at your card balances on a day of the month that you have $0 balance on it, they may view this as non-use of your credit. Credit scoring treats zero balances on a credit card as instances of non-use, which can have a negative effect on your score. Creditors like to see that you're still using credit, but doing so responsibly.

Most creditors will calculate your credit score right before your payment due date, when your debt to credit ratio is normally at its highest. This is done specifically so that the higher debt ratio can be used to raise your interest rate. Higher interest rates mean more profit for creditors. Managing the timing of your charges and payments carefully will enable you to increase your scores. Some experts suggest that you pay off your credit card bills as soon as you get them, to avoid interest payments. Then don’t use the card for one whole billing cycle until right before your credit card statement is prepared for the month, and then put a small charge on the card, somewhere between 5-10% of your available credit. There are a lot of internet experts touting what the optimum credit balance ratio is, but all fall within the 5% to 10% range, with 7% being a very popular suggested amount.

Other experts suggest not trying to get by with one credit card that has 100% utilization, but that it is better to have multiple cards, with each having an optimum balance ratio on the billing date. Be careful though when applying for additional credit cards, as card applications and credit inquiries are a negative mark on your credit report. Most lenders will lower your score if they see more than four to six credit inquiries in a six-month period.

Newer credit card accounts with a limited history will also bump your score much more slowly than cards that you have a longer credit history with. You have to allow time for your credit scores to go up when adding new credit accounts to your record. The length of your credit history is important. If you need to close a card, then close your newest cards first. As long as you don't have high balances or missed payments on any of the cards, there is no credit score penalty for keeping multiple cards open.

The bottom line is that by careful management of your credit card usage and payments you can still enjoy the convenience of using credit cards while also increasing your credit scores for significant purchases, like buying a house or car, where a slight increase in interest rates can cost you thousands of dollars over the life of a large loan.

This information is provided with the understanding that the association is not engaged in rendering specific legal, accounting, or other professional services. If specific expert assistance is required, the services of a competent, professional person should be sought.

Provided as a public service by the Pennsylvania Association of Community Bankers