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May 18, 2016

How a Credit Card Balance Can Affect Your Credit Score

Simple. Thrifty. Living.

Credit scores are used as an indicator of your financial responsibility, and having a high score can mean being approved to rent an apartment, paying less interest on an auto loan or even getting better rates from your insurance company. Carrying a credit card balance that’s too high can damage your credit score, even if you’re never late with a payment. Here’s why.

When credit bureaus score your ability to handle money, they look at your “debt utilization ratio.” This means how much of your available credit you’re actually using. Credit bureaus figure that an irresponsible person is more likely to max out all their credit options while a person who handles money wisely will generally use only a little of their available credit.

If you’re in the habit of using your credit card heavily all month and then paying it to zero at the end, you may still be harming your credit score. This is confusing, because you’re being responsible with spending, but the thing to remember is that credit bureaus don’t look at your credit card balance right after you pay each bill. Instead, they swoop in to take a snapshot of your credit balance at some random time during the month, and then use that balance as evidence of your overall indebtedness. Their reasoning is that they have no guarantee that you’ll use your next paycheck to pay down the balance. Because of this, you may not want to pursue credit card perks like mileage, even if the card issuer tries to tell you it’s a good idea.

The best way to use your credit cards is to make sure that you keep all the balances below 30 percent of the cards’ credit limits. For example, if you have a credit card with a $10,000 limit, you should never have a balance on it that’s higher than $3,000. It’s also important to realize that this advice applies to each credit card individually. For example, if you have a $10,000 limit card that’s completely paid off and a $2,000 limit card with a balance due of $1,900, your credit score will take a hit. In that situation, it’s better to transfer some of the debt over to the $10,000 card so the balance on each card stays below 30 percent of its limit.

Navigating the credit universe can be confusing, but when you understand the logic of the credit bureaus, you can stay ahead of the game.

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