Managing debt is a part of many people’s daily lives. Debt allows individuals to finance significant expenses such as home buying, car purchases, and education. Credit products also make daily consumption more convenient. However, the debt situation in credit records has a substantial impact on one’s financial status, affecting borrowing capacity, borrowing costs, and debt management strategies.
Credit cards have brought many conveniences to life, but if you cannot control your spending well, credit cards can also become a trap.
Matt Schulz, Chief Credit Analyst at LendingTree, told CNBC Make It that a prevalent myth about credit scores seems to persist, that is, carrying a balance on your credit card helps improve your credit score, but “that’s not true”.
Schulz pointed out that one of the reasons consumers find it difficult to differentiate is the vast amount of information on how to manage credit card debt and increase credit scores.
Individuals may fall into this myth because they do not fully understand how credit scores are calculated.
Payment history, 35%: How consistent you are in paying credit card bills and other loans on time.
Amounts owed, 30%: The amount you currently owe compared to your available credit, also known as credit utilization rate. Experts suggest keeping the utilization rate below 30%.
Credit history, 15%: The length of time you have been using credit, and the average age of your oldest and newest accounts. Typically, lenders prefer to see a longer credit history.
New credit, 10%: The frequency of recent credit card or loan applications.
Credit mix, 10%: The various types of debt you manage, such as credit card debt, student loan debt, or mortgage debt. While you do not need to have multiple forms of credit, maintaining multiple accounts can prove to lenders that you can manage different types of credit, thereby helping to improve your credit score.
Within these categories, many different factors can lead to an increase or decrease in credit scores. For instance, Schulz told CNBC that you might think carrying a balance can boost your credit score, but in reality, it may be due to one of your lenders increasing your credit limit, thus raising your credit utilization rate.
“There are so many variables at play that trying to pinpoint exactly why something changed is almost impossible,” he said.
When you carry a balance on your credit card every month, high interest charges can cause your debt to grow faster than expected. As of May 2, this year, the average credit card interest rate in the US hit a historic high, nearing 21%.
In the long run, accumulating interest charges can make your debt even more burdensome, especially if you only make the minimum payments. This is because the minimum payments are primarily applied to interest rather than helping reduce the principal balance.
Furthermore, as interest charges cause your credit card balance to increase, it could start raising your credit utilization rate, potentially having a negative impact on your credit score.
Ultimately, if you want to improve your credit score over time and avoid costly interest charges, do not believe the notion that carrying a balance is beneficial. Ideally, you should strive to pay off your balance in full and on time whenever possible.
“By 2024, life is already expensive enough. The last thing you need to do is pay more than you need to for something,” Schulz told CNBC. “Unfortunately, that’s exactly what’s happening for those who believe this myth.”
Typically, credit card statements will have three different payment options, namely: paying the statement balance, paying the outstanding balance, and paying the minimum payment.
The statement balance is the current outstanding balance, reflecting the amount charged to the credit card within the most recent billing cycle. The outstanding balance is simply the amount you owe the bank, representing the remaining balance not fully paid. In essence, the outstanding balance is the total amount you owe, while the statement balance only shows the amount owed at the end of the previous billing cycle (typically 28 days).
The minimum payment is the amount you must pay each month. If you pay less than the minimum payment, you may incur late fees.
Clearly, repaying the outstanding balance each month is the optimal choice as it leads to debt repayment in full. Paying the statement balance means you can enjoy interest-free grace periods.
One thing is certain—avoid paying only the minimum payment as much as possible, as this will only increase the interest that needs to be paid eventually, leading to mounting credit card debt.
(Note: This article is for general information purposes only and does not imply any recommendations. The publisher does not provide investment, tax, legal, financial planning, estate planning, or other personal financial advice. For specific investment matters, please consult your financial advisor. The publisher does not assume any investment responsibility.)