Welcome to the inaugural issue of Broke Millennial with Erin Lowry and the first issue of Ask Me Anything.
On Wednesdays, we wear pink…just kidding. (I swear that won’t be a weekly joke.)
On Wednesdays, I answer one of your burning money-related questions.
This week, in honor of April being financial literacy month, we’re tackling a myth that DRIVES ME NUTS!
Do I have to keep a balance on my credit card?
(aka “should I carry a balance month-to-month?”)
Short answer:
NOOOOOOOO!!!
There is never, ever a need to carry a balance month-to-month for the sake of your credit score. All that does is create credit card debt. The goal is to always pay off your credit card bill on time and in full.
Nuanced answer:
Do not feel embarrassed if you have carried a balance simply because someone told you that it was a good way to build your credit score. This is a frustratingly common myth that even gets promoted by perceived “financial professionals.” I was once on an Amtrak and overheard a mortgage broker lecturing a woman about how she should carry a balance on her credit cards to improve her credit score before applying for a mortgage.
To debunk this myth, it’s important for you to understand the difference between having a balance and carrying a balance.
Let’s us an example.
Having a balance: I just purchased some new makeup at Sephora and it cost me $100. I paid with my credit card. On April 25, when I get my credit card bill, it will say that my balance is $100 and that I owe a minimum payment of $25.
I will then pay the full $100 balance (not just the minimum payment of $25) so that I’m not carrying any balance over from April to May. In May, I will have a clean slate — I will have no debt and owe no interest.
Carrying a balance: Let’s say I make the same $100 Sephora purchase and on April 25, I get the same bill, with a balance of $100 and a minimum payment of $25. If I only make the $25 minimum payment, then I will be carrying a balance. The remaining unpaid $75 will carry over to May. This means that I will officially be in credit card debt and have to pay interest on the $75.
The origins of this myth
Okay, hang with me, because this can quickly become confusing.
Your credit score is made up of five factors and the second largest is something called a utilization ratio. It accounts for 30% of your credit score. Although it sounds fancy, it’s just is a complicated way of saying how much credit you use.
If you have a $1,000 line of credit and spend $100, then you utilized 10%. Your goal should be to use less than 30% of your available credit limit because that looks like a responsible use of credit according to our financial overlords.
Here’s why that matters.
It is a good thing to have a balance on your credit card when the bill arrives. If you use your credit card but pay it off immediately every month and your billing statement always says $0, then the credit scoring company could think that you have 0% utilization. Although you’ll have credit card debt, does it show thaty ou’re responsible? (We know you are, but the overlords don’t.)
What the credit scoring models want to see is that you can spend just a little of your credit limit every month and pay it on time. It’s a temptation game, and you need to prove that you can resist overspending in order to build a strong credit score.
Somewhere along the way, this got twisted from “you should have a balance” to “you should carry a balance” to order impact your utilization ratio and improve your credit score. If I were being a conspiracy theorist, I’d say that maybe the credit card companies themselves whispered this into our collective consciences many years ago in order to get more people into credit card debt. Luckily, you now know the secret!
To recap:
Spend no more than 30% of your available credit limit each month.
Wait for the bill to arrive.
Pay it off on time and in full.
Do not carry a balance over “for the sake of your credit score.” There’s no need.
*PSSST* Want to know a secret? You can get a 20% discount on an annual subscription to this newsletter by being an early subscriber. Go here and sign up for an annual plan before May 6, 2022.
Have a question you want answered for next week? Drop it into the comment section or DM me @BrokeMillennialBlog for a chance to see it answered.
Can you please do a post about the BNPL trend? I want to better understand the Math vs. Credit cards.