By Adam Jusko, ProudMoney.com, adam@proudmoney.com

For people trying to build a good credit history, credit utilization can be an important factor in raising their credit scores. Credit utilization — sometimes called debt-to-credit ratio — is the percentage of the available credit on your credit cards that you are actually using. For example, if you have $10,000 of available credit on a credit card (or cards) and you have a total balance of $1000, your credit utilization ratio is 10%.

While we advise keeping that ratio low — under 30% at least, but under 10% or even 5% if you want to be aggressive in building your score — some people worry that paying off their credit cards each month will put their utilization at 0% and thus not show up as a positive on their credit reports. This worry leads to some counter-intuitive (and wrong) advice about carrying a balance from month to month to show that you are using credit wisely.

Pay Your Cards Off In Full!

So, before we go any further, let’s be clear: carrying a small balance on your credit cards from month to month does NOT help your credit score. It is NOT necessary to pay interest in order to build your credit score. It will NOT increase your score faster than paying off your cards in full. Pay off your credit cards completely each month. Do not pay interest with the idea that you are somehow helping your credit history. You will end up paying good money for no benefit.



Why There May Be Confusion

Now that you know to never leave a balance on your credit card from month to month, let’s look at where this myth comes from. While you will not be rewarded for carrying a balance on your credit cards from month to month, you WILL be rewarded for actually using your credit cards and keeping a small balance DURING the month.

How can credit card companies know if you can handle credit if you never use the cards you have? They can’t.  Having a credit card that you never use may give you 0% credit utilization and a $0 balance, but it doesn’t show you can handle credit, because you’re not actually using that credit.  So if you want to improve your credit history, you do need to use your cards at least a little bit. This shows you can use the cards without overdoing it. However, when you get your bill, you still want to pay off the complete balance.

Credit Utilization Is Calculated During The Month, Not Just At The End

Your credit usage is not only reported at the end of a billing cycle after you’ve made your payment. It is also reported during that cycle, to show how much of your available credit you’re actually using. That’s why you don’t need to worry about carrying a balance from month to month — the credit bureaus already know that you had balances during the month!

This makes sense, right? Even if you pay off your balance in full each month, lenders would want to know if you usually use just a little of your credit or almost all of it. If you have a $5000 credit limit and you spend $4500 with the card each month, then pay it off completely, you’ve still used 90% of your available credit. Lenders could look at that utilization and think you are just one mistake away from being unable to pay your bills. On the other hand, if you have a $5000 limit and never use more than $500 of it, you appear to be less of a risk. That’s why credit utilization is reported in the way it is — to get a clearer picture of how credit is being used, even when the full bill is being paid off every month.

How To Keep Credit Utilization Low When Trying To Build Credit

Now that you know carrying a credit card balance and paying interest makes no sense, what should you do to make sure your credit utilization ratio is always low when it gets reported? Well, as mentioned already, you can charge fewer purchases in relation to your available credit, keeping that percentage below 10% or even 5%. However, if you have very low available credit and it’s difficult to keep utilization low, you also have the option to make multiple payments on your credit card each month, to guarantee that the reported balance will always make you look good and responsible.

For example, say you have $1000 in available credit and a $300 balance. You could make a mid-month payment of $250 to get your balance back down to $50. That way, you still show a small balance and good utilization ratio when the balance is reported. Then — and we can’t be more clear about this — pay off the FULL balance when your card payment becomes officially due later in the month.

I hope you can now see that paying credit card interest is never necessary to build good credit. Question? Leave it in the comments section below and I will try to reply ASAP.