Should I Keep My Big Checking Account Balance Or Pay Off My Credit Cards
The Credible Money Coach helps a reader with $14,000 in her checking account understand the value of paying off credit cards.
Dear Credible Money Coach,
I have about $5,000 in credit card debt at 21% interest. But I have $14,000 in a checking account that earns no interest. Would it be better to just pay off the balances on the credit cards? My credit score is under 720. Carolyn
Hi Carolyn, and thanks for your question. Congratulations on saving a significant amount of money!
To answer your question, lets look at how much emergency savings you need and how much you could save by paying off your credit card.
If you already have at least six to 12 months worth of living expenses on hand, then using your cash to pay down high-interest debt is a wise financial move. However, if you dont, maintaining a healthy cash reserve should be your top priority.But lets assume that your emergency savings are in good shape. Based on your question, you already realize that keeping a large checking account balance is rarely the best option because it doesnt allow your money to grow.
Now, lets consider how much your costs you in interest.
You Have Better Credit Cards
The credit card you had when you first started with credit, may not be as attractive as other credit cards you’ve opened over the years. It may have a low credit limit or high-interest rate while your other credit cards have better limits, low rates, and better rewards programs. Getting rid of a credit card that no longer benefits you is a good idea.
Keeping your oldest credit card open is good for your credit score because it demonstrates that you have years of experience with credit.
Take Advantage Of Rewards Programs
If you feel you are comfortably meeting your monthly credit card payments, and are able to put more charges on your credit card, you can take advantage of reward programs by moving some of your regular monthly expenses to your credit card. If you do this, try to make your monthly credit card payments at least the amount of those monthly expenses, so that you don’t get lulled into a false sense of financial security and start living beyond your means.
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What Should My Credit Card Utilization Be
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You probably already know that making credit card payments on time is key to building a great credit score. But did you know that credit card utilizationhow much of your available credit you’re using at any timeis a major factor as well?
In 2020, despite the pandemic, average credit card balances dropped by 14%, according to Experian data. This brought credit card utilization rates down and helped contribute to a record rise in U.S. consumer credit scores. Higher credit scores can give you access to the best credit cards and loan rates, helping to reduce the cost of borrowing money and land you extra benefits you might not qualify for otherwise.
A good rule of thumb when it comes to your credit card utilization ratio is that lower is better . Keeping your utilization under 30% is often essential to maintaining a good credit score or better.
Youre Trying To Improve Your Credit Score
Carrying a balance on a credit card to improve your credit score has been proven as a myth. The Consumer Financial Protection Bureau says that paying off your credit cards in full each month is actually the best way to improve your credit score and maintain excellent credit for the long haul.
If your goal is improving your credit score, the CFPB suggests taking the following stepspay all your bills early or on time, keep credit balances low, fact check your credit reports and dispute any errors you find, and avoid opening credit accounts you dont need.
You dont need to pay interest to boost or maintain good credit, so dont carry a balance because you think it will improve your credit standing.
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How Can I Achieve The Best Credit Score
How to get good credit: 5 expert tips: always pay on time. Its always. Optimize the use of credit. Using credit is another important piece of your credit assessment puzzle. Regularly check your creditworthiness for inaccuracies. Be strategic when taking on new debt and closing accounts. Look at your credit.
Fact: Paying Less Than The Minimum Is Still A Missed Payment
If you dont pay the total minimum payment on your credit card bill, your credit card company may report it as a missed payment. This can bring down your credit score and make it more difficult to qualify for credit in the future. Check your statement for the minimum amount due, and be sure to pay it on time to keep your account current. And remember: Paying more than the minimum amount due is a great way to pay down your debtand until you pay it off, interest will continue to be charged each month.
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Why You Should Pay Off Your Credit Card Each Month
When you pay off your balance on time, you can avoid interest being charged on those purchases.
The best time to pay off your balance is before or on the due date, after which the issuer may report your balance to credit agencies.
If this happens, you could see a dip in your credit score due to nonpayment.
In addition to avoiding interest payments, paying off your credit card balance each month gives you access to a grace period.
A grace period refers to the time it takes for an issuer to charge interest on a credit card purchase.
This usually starts on the last day of the billing cycle and ends when payment is due.
So, should you pay off your balance after every transaction?
While this may ease some anxiety about building up too much of a balance, paying off your card after every transaction is effectively not using any credit at all.
You want to use between 10% and 30% of your available credit to build your credit score.I
t shows credit bureaus that you are capable of responsibly using a line of credit.
How Is Credit Utilization Ratio Calculated
The general rule of thumb with credit utilization is to stay below 30 percent.1 This applies to each individual card and your total credit utilization ratio. Anything higher than 30 percent can decrease your credit score and make lenders worry that youre overextended and will have difficulty repaying new debt.
Experian finds that credit utilization ratios vary by age group.3 The Silent Generation averages 16 percent, followed by Baby Boomers at 29 percent, Gen X at 36 percent and Millennials and Generation Z at 37 percent. Interestingly, younger groups tend to have lower balances than their elders but their credit limits are also lower, so their credit utilization ratios can still be high.
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Is It Bad To Pay Your Credit Card Twice A Month
Making all your payments on time is the most important factor in credit scores. Second, by making multiple payments, you are likely paying more than the minimum due, which means your balances will decrease faster. Keeping your credit card balances low will result in a low utilization rate, which is good for your score.
Pay As Much As You Can Each Month
If you can make higher repayments each month, you will pay off the debt faster and save money.
Work out the fastest way to pay off your credit card.
If you only pay the minimum, you’ll pay a lot of interest and it will take years to pay off your debt in full.
If you’re finding it hard to pay the minimum amount, contact your bank or credit provider straight away or talk to a free financial counsellor. Taking action early stops a small money problem from getting bigger.
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Youre Using A Credit Card To Earn Rewards
The credit cards with the most perks, including travel rewards credit cards, tend to charge the highest APRs in order to make up for their benefits. This creates a situation where many people who pursue rewards wind up overspending and carrying a balance, which means the interest they pay is easily wiping out the value of any rewards earned.
Consider that the average credit card APR is well over 17%. At the same time, most rewards and travel credit cards cap earnings at 4% back in bonus categories and up to 2% back in regular spending categories.
Even if you transfer points to an airline partner to pay for pricey business class flights or other luxury travel, you would be incredibly hard-pressed to get value that is anywhere close to the credit card interest youll pay.
How Does Credit Limit Decrease Can Affect Your Score
How does lowering your credit limit affect your credit score? Lowering your credit limit can hurt your credit score by increasing your overall credit usage when you have a high balance on your card. Credit utilization is 30% of your FICO score, and the highest spending card can lower your score by 45 points.
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Secured Or Other Cards For Bad Credit
Rebuilding a bad credit history sometimes means accepting credit cards with high-interest rates, low credit limits, annual fees, or security deposit requirements. While these credit cards are great for proving that youve rehabilitated your bad credit habits, theyre not keepers. You can close one of these “starter” credit cards as soon as you’re able to qualify for something better. When you’re building or rebuilding your credit score, aim to qualify for better and better credit cards.
Its Commonly Said That You Should Aim To Use Less Than 30% Of Your Available Credit And Thats A Good Rule To Follow But Theres Really No Magical Utilization Rate Cutoff For Every Scoring Model
Using less of your available credit is generally best for your credit scores because using a large amount of your available credit could mean youll have trouble repaying that debt. If you want to keep your scores healthy and your credit reports in good shape, you should try to use as little of your credit as possible.
But the right utilization rate for you might depend on a number of factors, including the state of your credit reports in general, the number of credit accounts you use and your overall financial health.
Read on for a closer look at how to manage and assess the amount of credit you use.
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Only Apply For Credit Cards When You Need Them
Another page from the book on improving your credit score is to open credit cards only when theres a good reason to. For example, if you have a high credit balance thats over 30 percent of your credit limit. Opening up another card could make sense in these cases to improve your utilization rate.
Another reason that you might want to apply for a new credit card is that it offers an intro balance transfer rate that will save you money. Make a plan to pay off that balance before the intro rate ends because the interest rate afterward is usually very high.
If youre a few months away from taking out a loan for a big purchase like a home, you should stay away from applying for credit cards. Each time you apply for a credit card, a hard inquiry will appear on your credit report. This will ding your credit score and may impact whether youre approved for a mortgage loan and the terms you get.
This also happens when you apply for a loan. If you want to search and compare interest rates, most lenders will allow you pre-apply, which is a soft pull. This wont affect your credit as much but Experian recommends applying with these different lenders within a short time frame so it doesnt impact your credit.
You Dont Need To Carry A Balance To Keep A Card Active
Brewer thinks that some people may be misinterpreting the advice theyre given confusing showing lenders youre using credit with having a balance. While regular use and timely repayments help show lenders that youre a responsible borrower, consumers can prove their creditworthiness without having to pay a penny of interest.
Keeping a card active is important, but there are many ways to do this without carrying a balance. One of the simplest may be to use your card to automatically pay a small recurring expense such as a subscription to Netflix that you pay off monthly. Some checking accounts can be set up to pay the credit card bill in full when its due, automating the whole process.
If your card remains inactive, the issuer could close the card or stop reporting the cards activity to the credit bureaus. If this happens, that cards limit likely wont be included in your overall credit limit. Then if your usage or balance remains the same, the percentage of the available credit youre using would increase, which could negatively impact your credit score.
If the issuer closes the card, the average age of your open accounts may also decrease which could potentially hurt your score, as your length of credit history is another factor that can be used to calculate your credit scores.
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Pay As Much Of Your Credit Card Balance As You Can Afford Each Month
The optimal budget goal is to pay off your entire credit card balance every month, especially if you’re opening your first credit card account. In doing so, you’ll avoid paying interest on your card.
If you can’t pay your balance off in full, do your best to pay more than the minimum monthly payment. That will help to reduce the interest accruing against your balance each month.
How Canceling Your Unused Credit Card Impacts Credit
It might sound counterintuitive to keep a credit card account open if you’re not using it. That’s especially true if you believe closing an account will keep you from overspendingwhich is a sound impulse. But closing a credit card could negatively affect your credit score. Here’s how:
- Increased credit utilization: Your is the amount of revolving debt you currently have compared to your total credit limit. The lower the rate, the better. That shows lenders you’re not maxing out your cards, and you can be trusted to use credit responsibly if they extend it to you.
Getting rid of a credit account affects the amount of credit you have available. For instance, if you have a credit card with a $2,000 credit line and another with a $3,000 credit line, your total available credit is $5,000. If you currently have $1,000 in debt between the two cards, your credit utilization rate is 20%.
Say your $1,000 balance is on the card with the higher credit limit, and you decide to close the other. When you close the card with a $2,000 credit line, your available credit decreases to $3,000 total. With $1,000 in credit card debt, your utilization rate jumps to about 33%. Credit utilization accounts for 30% of your FICO® Score, the most common score used by lenders, so this change can have a significant impact on your score.
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How To Improve Credit Utilization Ratio
If you think your credit utilization ratio is holding your credit score down, you can use these five strategies to improve it.
1. Pay down debt. Reduce your credit card balances by paying more than the minimum each month. Consider making two or more payments on your credit cards throughout the month even small extra payments can speed up debt payoff and help keep your utilization ratio throughout the billing cycle. Just make sure to avoid charging more on your cards.
2. Refinance credit card debt with a personal loan. Refinancing credit card debt with a personal loan can help in more than one way. First, consolidating multiple credit card balances into one lower interest rate loan can reduce the amount of interest that youll pay on that balance over time, which means you can pay more toward principal and eliminate the debt sooner. Second, many people find it easier to stay on top of a single monthly loan payment instead of multiple credit card payments. Lastly, if your credit cards remain open after transferring the balance to a personal loan, your credit utilization ratio goes down. If you keep the credit cards open and dont run up a balance on them again, that can help your score over time.
5. Leave cards open after paying them off. By paying off the card, youre reducing your total balance. By keeping the card open, youre maintaining your total credit limitthereby lowering your credit utilization ratio.
Experian Boost Can Help Your Credit Score
In the past, you were not able to get “credit” for making all your utility and cellphone payments on time. Now, with Experian Boost, you can sign up to have those positive payments added to your report and included in your Experian FICO® Score. This can be especially helpful for individuals with a “thin” credit file or those with credit scores below 680.
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