When you go through any financial or major life change, your credit score is one of the first things a lender or bank will look at.
Because of the significance of credit, there are many credit myths. One of them is having debt improves your credit score. Paying off all debt – whether it’s on a credit card or loan – actually improves your credit score.
But there are ways to have a little bit of debt and still have a great credit score. For this article, we’ll look at debt on credit cards and how credit card debt affects your credit score.
Should You Have Debt on Your Credit Cards?
The short answer to this question is no. The best practice with credit cards is only spending what you can afford. Pay off the credit card in full every month – ideally, before the due date.
But this is always a best-case scenario. Sometimes, life happens. There’s an unexpected charge or an emergency situation that calls to spend more money than you have, especially if you only make minimum wage.
In this situation, most people open a credit card with zero or low APR and pay off the credit card throughout the year.
Fortunately, for these situations, your credit score won’t be affected as drastically. That’s because the credit score determination is extremely complex.
How Your Credit Score Is Determined
Before we understand how much credit card debt you can get away with, let’s focus on how your credit score is determined. Your credit score is a number that measures your credit use.
A higher score means you have great credit usability and can pay it off. A low credit score can mean one of two things: either you use a lot of credit and can’t pay it back or you don’t use credit at all.
Credit scores range from 300 (lowest) to 850 (highest). If your credit score is over 740, you have a great credit score. But if your credit score is below 650, this is considered a bad credit score.
Here are the factors FICO uses to judge your credit score:
- Payment history
- Amount owed
- New credit
- Different types of credit
Referring back to the subject, you can see your debt isn’t the only factor that’s measured.
Actually, the amount owed isn’t the most important factor: your payment history is 35% of your score and the amount you owe is 30% of your score.
There are also smaller factors that contribute to your score. This includes how long you’ve had your credit card, if you opened any new ones, and different types of credit.
These types of credit include a loan such as a car loan or a student loan.
What’s the Best Amount of Debt?
Are you looking at your credit card statement and are wondering if you’re in too much debt? There’s no one-word answer to this question.
The best thing to do is look at a few things:
- Your credit card limit
- Your balance
- How much you’re paying
- How long you’ve been off the card
Let’s look at these factors individually. And if you’re still unsure about your credit card debt, Ask National Debt Relief.
Your Credit Card Limit
When you first sign up with a credit card, you’re usually given a low limit. As you use the card, the limit increases. The amount of debt you owe determines your credit score.
It’s best to not exceed 30% of your credit card limit unless you’re positive you can pay it back.
For example, if your credit card has a $3,000 limit, don’t exceed $900 unless you’re positive you can pay it all off by the due date.
As stated previously, your balance has a lot to do with your credit score. And this also is determined by your limit.
Let’s give the previous example again. If your credit card limit is $3,000 and your credit card debt is at $700, you’re probably fine. But if your debt is at $1,000, even that little bit of an increase can affect your credit score.
How Much You’re Paying
When you pay off your credit card, do you pay more than the minimum? If not, you should.
Unless you have a zero APR credit card, you’ll be charged an interest rate. For most credit cards, the interest rate is 18%. This means you can be charged as much as $30 each time you don’t pay off your credit card in full.
If you only pay the minimum, you’re pretty much only paying interest.
Paying off more than the minimum results in a quickly paid off credit card and less interest rate worry.
Let’s say your credit card minimum is $25. See if you can pay off $75 every month. The $50 extra will cover both the interest and will pay off a little on your card.
How Long You’ve Been Paying Off the Card
Credit length can either positively or negatively affect your credit score. This can go one of two ways: paying off a credit card for a long time can both benefit and hurt your score.
Let’s say you owe $1,000 in credit card debt. If it takes you four months to pay it all off, your credit score will probably be positively affected. But if it takes you three years to pay it off, your credit score will decrease.
Now, let’s say you put $1,000 on your credit card and pay it off in full every month. Since you’re using that one credit card for a long time and have a positive payment history, your credit score will increase. Most credit cards come with insurance that ensures the repayment of your loan through PPI companies.
Keep That Credit Score Up!
Credit cards can positively or negatively affect your credit score. Just know to never put more than what you can afford on a credit card. Yet, many people find themselves in credit card debt.
Pay more than the minimum payment and always pay on time.
For more financial advice, continue reading our blog.