As a reader of our HOPE4USA Credit Blog you already know that credit cards can potentially be a very powerful tool - when used properly - to help drive your credit scores upwards. A credit card with a $0 or very low balance can potentially help to give your credit scores a substantial boost. If you need some more great credit boosting tips check out this article for some of my favorite suggestions.
Lately I have noticed a lot of confusion regarding whether or not it is best for a consumer to carry a balance on a credit card in order to receive a potential score boost from FICO. For a long time, I have held the opinion that carrying a $0 balance on a credit card is always the best way to go. However, as I have consulted with professionals whom I respect within the mortgage industry I have found that many of them have the opinion that a consumer should carry a $10 balance to achieve the maximum score increase possible. So I set out to research the topic. What I have found is that the truth is actually somewhere in between the 2 opinions.
FICO rewards consumers (with points added to their credit scores) when the consumer has a 0% utilization ratio on a credit card or, in laymen's terms, a $0 balance. However, FICO rewards consumers just a little bit more when they have a 1% utilization ratio. What does a 1% utilization ratio look like? Here are a few examples:
1. On a credit card with a $300 credit limit a balance of $3 = a 1% utilization ratio.
2. On a credit card with a $500 credit limit a balance of $5 = a 1% utilization ratio.
3. On a credit card with a $1,000 credit limit a balance of $10 = a 1% utilization ratio.
This means that if a consumer has a credit limit of only $300 and they are carrying a $10 balance then the consumer is above the 1% utilization ratio and, therefore, is not receiving the full potential score benefit from that card. In fact, the consumer is losing some of the points that he or she would receive if the same card had a $0 balance. However, on a credit card with a $1,000 credit limit then carrying a $10 balance is a good idea in order to receive the maximum points available. Don't look at a zero balance as a bad thing. It is awesome. But, a 1% balance on a credit card is awesome + 1.
Another factor to consider is how difficult it is to actually have a precise 1% balance show up on a consumer's credit report vs. a $0 balance. Let me give you another example. Joe Consumer wants to boost his credit scores as much as possible before applying for an upcoming mortgage loan. Joe has a VISA with a $300 limit. Joe knows that 1% credit card utilization ($3 on his $300 VISA) can help to improve his scores. So Joe goes to his local mall on July 1st and charges $50 on his VISA. Unbeknownst to Joe, VISA reports the $50 balance on July 3rd. On July 5th Joe pays the $50 balance down to $3 which equals a 1% utilization ratio on his VISA card. However, on July 10th when Joe's loan officer pulls his credit report the balance on his VISA is being reported as $50 NOT $3. Joe's limit of $3 will not be reported to the credit bureaus by VISA until August 3rd (assuming that Joe does not use the card for any additional purchases in the meantime). Because Joe's VISA is at a $50 balance, which is a little over a 16% credit utilization ratio, Joe lost potential points that he could have gained with a $0 limit.
Therefore, my recommendation in most cases is still that a $0 balance on a credit card is the best way to go to help boost credit scores. If you have time to play around with your balance for at least 60 days prior to a loan to try to reach the perfect 1% credit card utilization ratio - go for it! Never turn down extra points. However, if you know that you are going to be applying for a large auto loan or mortgage within the next 45 days then your best bet is to keep a $0 balance.
Either way you go - $0 balance or 1% credit utilization ratio - you will be showing the credit bureaus that you are a good credit risk. While you have the right to fully utilize the entire credit limit on your credit card accounts you are choosing to exercise discipline and financial restraint. In other words, you are not maxing out your credit cards each time the shoe store comes out with its hottest new releases. Showing the credit bureaus that you have this discipline and restraint will result in a reward - extra points for your credit scores!
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Michelle Black is an author and a credit expert with over a decade of experience, the credit blogger at HOPE4USA.com, a recognized credit expert on talk shows and podcasts nationwide, a contributor to the Wealth Section of Fort Mill Magazine, and a regularly featured speaker at seminars up and down the East Coast. She is an expert on improving credit scores, credit reporting, correcting credit errors, budgeting, and recovering from identity theft. You can connect with Michelle on the HOPE Facebook page by clicking here.
