I often get inspiration for my blog posts from people I interact with. I learn of my readers’ needs through talking with friends, acquaintances, colleagues, and everyone else with whom I have a conversation that involves personal finance matters. In a recent conversation like that, I learned of someone who keeps her credit active by making a large purchase on her credit card and paying the balance gradually, over months, obviously accumulating and paying interests. She learned of this practice from someone else.
You know that I advocate paying off balances before due dates so you’d never pay a penny in interest. Let’s discuss which approach is better for your credit.
Each credit account has a statement closing date on which the creditor communicates to you the amount you owe and the minimum required payment to be made by the next payment due date. The amount you owe at this point is reported to the consumer reporting agencies (CRA’s). As long as you have a non-zero amount when the statement closes, someone looking at your credit report will know that you are using your credit card.
Except in special cases, your account balance gets reported to the CRA’s monthly, at the statement closing date. As soon as the balance gets reported to the CRA’s, you can pay off the balance without affecting what’s been reported. As you know, your credit history is composed of all information reported to the CRA’s. What is not reported does not count, and that is why it is unnecessary to carry a balance.
So all you need to do is to make a small purchase on your card every few months, wait for the statement to close and the balance be reported, then pay off the balance. This way you will show some usage on the card, and not pay any interest.
Equifax and Experian, two of the three CRA’s, have written about this:
From http://blog.equifax.com/credit/top-five-credit-myths/ :
“While you do want positive account activity, such as paying a credit card bill on time, there’s no need to carry a balance. Simply paying off a small purchase every month (or every few months) will typically trigger the credit company to report that behavior.”
From http://www.experian.com/ask-experian/20110914-use-cards-a-little-and-pay-balances-in-full-to-build-credit.html :
“Use at least one of the cards to make small purchases each month. However, you should not carry a balance. Instead, pay off the charges each month so that you don’t carry a balance from one pay period to the next.
Making small purchases will keep the card active and keep your balance well below your credit limit. This demonstrates that you consistently manage debt well and can add positive points to your credit scores. Paying the balance in full will prevent paying interest or finance charges on revolving balances.
A combination of using the card but paying off charges to maintain a zero balance will likely improve your credit scores over time.“
In short, carrying a balance does not help you build credit.
Richard (Hiep Tran)
2 thoughts on “Do you need to carry a balance to build credit?”
Is it better to use credit cards up to the maximum limit?
Let’s say I have a card that has a $2500 limit.
Would you recommend to use this card up to $2400? or $200?
Can the amount of money that you use each month possibly affect your credit score?
If not, should I just use my debit card instead if I have to keep my balance low?
As long as you pay down the balance to <10% of the credit limit by the statement closing date you'll be fine, as far as credit scoring goes.
Sometimes when you apply for credit the credit analyst/loan officer will scrutinize your credit profile more carefully and investigate your daily high balance history. If your card has a $2.5k and the credit analyst sees that you've been consistently using 90% of the available limit, that would indicate an unhealthy financial management habit and raise a red flag. If you have to make a large purchase, I suggest paying off the balance on the same day, or even before you make the purchase.
For example, when I had my BofA secured card with a 2k limit, there was one time when I had to make a 1.7k purchase. Right after running the purchase through my card, I transferred money from my BofA checking account to the credit card to pay off the 1.7k, and by doing that protected by daily high balance history.
If you need to run a large transaction, you want to use your credit card for maximum fraud protection. If you want to be safe credit-wise, make sure you make a payment quickly afterwards. I would say that it is healthy to keep the daily high balance below 50% of your credit limit.
Also, once your credit limit gets increased, the current high balance would matter a lot less. 😉