A credit card is a payment card issued to users to enable them to pay a merchant for goods and services based on the cardholder's promise to the credit card issuer to pay them for the amounts used- borrowed- plus the other agreed charges. The credit card issuer creates a revolving account and grants a line of credit to the cardholder, from which the cardholder can borrow money up to the credit line’s credit limit.
But, your credit card balance is much more than just the amount of money you owe to your credit card issuer. What do we mean by this? Well, your credit card balances directly affect what your credit score looks like and, ultimately, whether you are able to get approved for new credit accounts in the future.
This is because, much like other types of credit, your credit card, along with its activities and balance, are reported to the Credit Reporting Bureaus-Experian, Equifax, and TransUnion, which is added to your credit report. And as your report gets updated, so too will your credit score to reflect your credit card balance.
Your credit score is a three-digit numeric grade, that ranges between 300 and 850, which indicates your creditworthiness, or your likelihood to pay back a debt, at a specific point in time. The higher your credit score, the less risk you pose to lenders, and the more they are willing to extend you credit.
Your credit score is calculated based on the information in your credit history, listed in your credit report, which includes things like credit cards, loans, and other debt accounts. In addition, credit score calculations also consider Information such as your account balance, payment history, credit limit, as well as your accounts’ age.
And while each type of credit score is calculated differently, most, if not all, consider the same factors, but only at different levels. For the purposes of this article, we will be focusing on FICO credit scores, the most commonly used credit scoring model by creditors and lenders.
Here are the key factors that affect your credit score, as well as their significance in the calculation, represented as a percentage:
- Payment History (35%)
- Credit Utilization (30%)
- Length of Credit History (15%)
- Credit Mix (10%)
- New Credit (10%)
Your Credit Card Balance and Your Credit
Credit utilization, the second most important factor that affects your credit score, is the ratio of how much credit you are using or how much balance you have relative to how much credit is available to you or your credit limit.
A lower credit utilization ratio is better as it demonstrates that you can responsibly use credit and that you have not overextended yourself with high credit card balances. In short, having a lower percentage of credit card balances compared to your credit card limits will reward you with higher credit scores. The opposite is also true. Higher credit card balances will lower your credit score.
While there is no official guideline as to what constitutes a “high” credit utilization ratio, you should strive to keep your credit usage below 30%. For instance, if you have a credit card with a credit limit of $1,000 and a credit card balance of $500, your credit utilization ratio is 50%, which is a “high” utilization ratio.
Once your balance starts to exceed the 30% utilization threshold, you will start to notice your credit score decreasing. Meaning, if you habitually max out your credit cards, your credit score could drop very significantly.
How Much Credit Card Balance Should You Have?
The absolute best balance you should have on your credit cards is $0. However, unless you are never using your credit card, it is almost impossible to maintain a zero balance on your credit card, especially if you use it fairly regularly.
With that in mind, you only need to get your credit card balance to $0 at least before the account statement closing date. This ensures that when your credit card issuer reports your account to the credit bureaus, your balance is $0. In addition, you also avoid getting charged with interest and fees, which are associated with balances that carry over the next billing cycle.
The Bottom Line
To sum up, credit cards allow you to access a credit line. However, how much you can borrow will depend on your account’s credit limit. And since you are borrowing against this limit, your balances pushes your utilization ratio higher, which is 30% of your FICO credit score.
If you are not able to maintain a $0 credit card balance, then consider getting a credit limit increase as a workaround. The higher your credit limit, the more you can borrow against it, and the lower your credit utilization ratio.
However, to obtain a high credit limit credit card, you need to have good credit. If your credit score is preventing you from getting a credit limit increase, you need to get it fixed. Call us at 888-799-7267 to schedule a Free Consultation.
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