Burning question: What’s the *right* balance to keep on a credit card?

CapitalOne.com
CapitalOne.com

You probably know by now that your credit card balance impacts your credit score. And you might know that even if you pay your bill in full each month, running up high balances can have a negative impact on your score. For example, maxing out a card can cost you between 25 and 45 points, as I reported last month. We all know how important it is to stay on top of our finances. It isn’t always easy, especially when you have access to credit cards that you can use whenever you want. But when you start building debt on those cards, many people find it hard to get out of it. If this is a situation you currently find yourself in, you may want to take a look at sites such as PriceofBusiness.com for some financial guidance. The more you know when it comes to finances, the better this could be for you in the long run.

This has led several readers to ask a simple question that turns out to be not so simple: What is the *right* credit card balance? In credit industry language, what is the right “credit utilization ratio?”

The short answer is pretty close to $0. But definitely not $0. It’s also definitely not 20 or 30 percent of your available credit, both numbers I’ve heard from readers.

Before I go any further in this discussion, let me make something absolutely clear. I am talking about intra-month balances here. Debt acquired during the “grace period.” There is no good reason, ever, to carry a balance from one month to the next and incur interest charges. I’ve seen people make this mistake, thinking they were somehow helping build their credit, and it couldn’t be more wrong. It’s always the right move to pay your bill in full by the due date. Losing actual money is always worse than losing credit score points. But paying your bill in full doesn’t hurt your credit score, anyway.

On to our story. While credit scores are becoming more widely available to consumers, the formula used to construct them is still shrouded in mystery. We have a rough idea of what goes into them. But folks who try to fine-tune their scores are running a bit of a fool’s errand. That’s one reason some folks who watch their score every month care so much about credit utilization. It’s one thing that you can actively control.

To review, utilization is a simple concept. If you have four credit cards that together have a credit limit of $10,000, and you are carrying $2,500 in debt on them, you are using 25 percent of your available credit — or 25 percent utilization. The folks who make credit score formulas have seen in the past that when consumers suddenly run up against their utilization limits, they are running into financial trouble and the odds go up that they’ll miss a payment soon. They are hit with so-called “damage points,” and their credit scores go down. Simple enough. In our mythical example above, if a consumer gets to $9,500 in credit card debt, it does seem logical they might have run into financial misfortune. (Set aside, for now, any moral outrage that the debt might come from a personal emergency and it might not be fair to punish this person. That’s a topic for another story.)

A more difficult question is: At what point are credit scores punished? At 80 percent? At 60 percent?

To answer this question, I turned to Barry Paperno. He’s a credit expert and former credit industry insider with FICO and Experian. He now writes about credit for CreditCards.com and his own site, SpeakingOfCredit.com.

Hit surprise answer: less than 10 percent. In other words, our perfectionist credit score watcher from above should try to never run her or his total balance as high as $1,000 during any time of the month. In fact, a more accurate answer is between 1 and 9 percent, says Paperno. That consumer should never have outstanding charges that add up to more than between $100 and $900 at any time during the month

Wow!

Before we proceed, I must make two points. First off, credit scores are very individual and ephemeral. No two adults’ credit situations are the same, and that means there’s no way to say precisely how this or that single factor will impact a person’s score. It’s a complex formula. I can’t say that going from $1,000 to $2,000 in credit card debt will cost you 10 or 20 or 30 points on your credit score. In all likelihood, other factors will play a bigger role — even something as trivial as what day of the month your score is calculated.

Second, I feel the need to say this with all credit score discussions. I don’t think it’s a good idea to worry about your credit score so much that you notice month-to-month, 10-point fluctuations. I worry folks who do that have fallen for a bit of a trap set for them by the credit industry, playing the game that the industry wants them to play. Most times, these changes don’t matter. It’s a little like being grade-focused in a pass/fail class. There’s no real difference between a 770 credit score and a 750 score, for example.

Paperno puts it this way: “It’s like worrying about getting A+ (grades) when they won’t get you anything a B can’t.”

All that aside, here’s a more detailed explanation about the *right* credit card balance.

First off, a $0 balance isn’t great. If you have a credit card but never use it, the credit scoring formulas will think you are dead, or at least the credit equivalent of being dead.

“Utilization doesn’t only measure the amount you owe in relation to how much has been made available. It also tries to look at how recently credit cards have been used with the idea that not only does lower utilization lead to lower future risk, but scores are most accurate in their predictions when there has been recent credit activity (vs. non use of credit),” says Paperno. “For this reason, scores like to see a very small balance reported recently: 1 to 9 percent tends to be optimal, as an indication that the card has had recent use. Otherwise, with a zero balance, the score has no way of knowing if there has been any recent activity, since scores don’t use historical balance/limit information in the same way they uses historical payment data.”

In other words, late payments hurt you forever (well, for seven years), but spending only helps you for a few months.

“However, there isn’t much difference between 1 percent and 0 percent, whether on an individual or combined account basis, so no one should panic if it turns out they didn’t use a card one month,” Paperno added. “Still, it’s definitely a good idea to keep at least one card active at all times for various scoring reasons. As long as the combined utilization comes in somewhere around 1-9 percent, you should be happy with your score.
“Long story short, there is one basic principle regarding utilization that I’ve found always applies: Lower is better, but something is better than nothing. Simple as that….The ideal thing to do is use a few cards and leave only a few dollars on each one, while avoiding finance charges at all times.”
One special point for folks with minimal credit history, such as young adults or recent immigrants, who are working to build up their credit: It’s even more important to keep usage between 1-9 percent, says Paperno. For folks without other borrowing and repayment records in their credit report, credit utilization has an out-sized impact on their score.
When I asked the folks at FICO about the *right* right credit card balance, they essentially agreed with Paperno. They pointed me towards this infographic which says that “high achiever” credit consumers, whose scores are near 800, have an average utilization of 7 percent.
If you’ve gotten this far in this story, you are almost certainly a clever user of credit anyway. But just to repeat the essential message here: By far, the most important thing you can do to help your credit is simply pay your bills on time. We’ve learned recently that even a $100 bill reported as paid late by 30 days can damage a credit score by nearly 100 points, with the punishment lasting up to 3 years. The better your score, the deeper the punishment. In the face of that reality, this credit utilization stuff sounds a little silly.
But as a healthy rule of thumb, in the course of your normal spending habits, try to keep your credit card balances under 10 percent of your available credit at all times.

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About Bob Sullivan 1515 Articles
BOB SULLIVAN is a veteran journalist and the author of four books, including the 2008 New York Times Best-Seller, Gotcha Capitalism, and the 2010 New York Times Best Seller, Stop Getting Ripped Off! His latest, The Plateau Effect, was published in 2013, and as a paperback, called Getting Unstuck in 2014. He has won the Society of Professional Journalists prestigious Public Service award, a Peabody award, and The Consumer Federation of America Betty Furness award, and been given Consumer Action’s Consumer Excellence Award.

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