I wanted to do something a little bit more constructive than write an article with this title, but today it looks like I’m going to reduce myself to cleaning up rumors. Yes, rumors; you know, that friendly little bit of “advice” that at least one person decides to regurgitate when someone mentions “credit score”. It usually goes something like this:
My friend told me that if you want to build credit quickly, you should leave a small balance on your credit card so you can build trust with the bank. If you pay interest, they will see that you are a trustworthy consumer, and that you can handle paying them off. Otherwise, it looks like you’re not utilizing your cards and that looks bad on your report.
Usually when I ask where people heard this, they say it was their friend who works as a teller, or maybe a friend who sells cars for a living, or someone who does collections at a hospital. News flash: not everyone who works in a hyperbolically related industry knows what they’re talking about.
Reasons to Never Carry a Credit Card Balance
Not only is the statement above false, but even if it weren’t false, it’s still horrible advice. With most credit cards nowadays running an average of 15-20% APR, you can’t afford how bad this advice is. And that’s if it weren’t a complete and utter lie.
Let me give you a small tip that might save you hundreds of dollars a year the next time someone farts out something like that: You don’t need to pay a dime in interest for a good credit score. If you do, you’re paying a premium for something that’s exactly the same as the free version. And the free version goes something like this:
Always pay your statement balance in full, every month, by the due date. This will allow you to avoid paying interest, and your credit utilization will be recorded for free.
It’s really just that simple, and it’s the only way you should be building your credit score. Paying interest doesn’t improve your score faster. It only costs you money, and it makes you look pathetic when you have to explain to your new finance girlfriend why the size of your savings account is so small.
What is the credit card interest charge?
All right, zonination. If you’re so smart, then why is this “rumor” false?
I’ll tell me why. It’s because the interest that you pay on a credit card is not reported to the credit bureaus.
When you receive your statement, the statement balance is the number that is provided to the bureaus. This is the grand total that appears on your monthly statement from the bank. For credit cards, the bank also reports your available credit. If you’ve ever looked at your credit report (which you should do every year), you will see that the only two numbers reported on your accounts are your statement balance and your available credit. The month after your statement, they record whether you paid on time. Wash, rinse, repeat.
It’s almost completely needless to say that the FICO algorithm uses only these three criteria when calculating your payment history and utilization. In case the gears aren’t turning in your head, this means that interest paid has no additional effect on your score. So it’s really just the same as paying your statement balance in full by the due date. Imagine that.
But my friend X is an expert who works for Y, and s/he told me to carry a balance!
Your friend is an idiot, and s/he is costing you a fortune. You’re free to believe what your friend says, but that only makes you both wrong. Just because X claims something doesn’t mean it’s true.
But if you really want to throw your hard-earned cash into an eternal abyss of broken promises on behalf of your so-called expert’s advice, I suppose I can’t stop you. It’s your money, after all, and you’re free to waste it on whatever you want.
How does carrying a balance affect your credit report?
But I’m nervous that paying in full might look bad on my report.
Look at what I just said above. The only things your bank’s monthly report contains are your statement balance, available credit, and whether you paid on time. Interest is not recorded and there’s nothing to get nervous about.
When your statement balance comes in, you’ve been recorded. You will already look “good” utilizing your credit as long as your statement says something other than “0”. Then your choice is whether or not to pay in full.
Really, the only thing that will make you look bad are the bankers snickering at you behind their mahogany desks, all because you believe a rumor that pulls a ton of revenue from suckers who fall for this kind of crap.
That’s just your opinion, though. I followed X’s advice, and it worked!
The reason it worked is because, in addition to paying interest you never needed to pay, you also built a payment history which would have happened anyway. Your credit score didn’t get “bonus points” or “extra trust” because your bank made some quick cash off of you. Your credit score got a boost because you made on-time payments that got reported to the bureaus. It would have worked exactly the same if you had paid your statement in full.
What if I took out a loan to improve my credit score instead?
What? Whoa, wait! No. Let’s back up here. Look at what I said above. You don’t need to pay a dime in interest for a good credit score. Obviously, while it’s disappointing that there is no quick way to build a score, you don’t need to take out a loan. Credit cards are a loan, and paying them off in full every month builds a good enough payment history to bolster your score without paying interest. There are tips and tricks to boosting your score that I will examine later on, but “starter loans” are only a last resort.
What I’ve been trying to say for this whole post is that paying interest when you can afford to sidestep it is stupid. The whole point of having a good credit score is to pay lower rates on loans that you need to take out. Paying interest to avoid interest is an exercise in wastefulness, and it’s completely unnecessary when you can build your score for free.
So if there’s one thing I want you to take away from this, it’s that you can build a good credit history without paying the premium rate. Repeat after me: I, [name], will always pay my statement balance in full, every month, by the due date.