Credit cards can be pretty awful. But for most people, they’re not that bad. They can be good tools in the right hands (for building credit and for earning points, for example).
I have never had or used a credit card – ever. But I’m not against credit cards for everyone – I just prefer not to use them because I’m a spender and don’t want the temptation.
Despite not having used credit cards, I know a lot about them (being a personal finance blogger and financial planner does that!).
So, I want to share with you the worst credit card myth I’ve ever heard.
A few years ago, my brother shared this myth with me. He didn’t know it was a myth at the time. He thought it was true. Fast-forward to a few weeks ago and someone else told me this same myth.
The Worst Credit Card Myth
The worst credit card myth you can fall for is: “You have to carry a balance on your credit card to build credit.”
This just isn’t true. Not one bit.
My dilemma is that most people reading my blog will already know this as true So, if you are one of those people who knew this as a fact, I ask you to forward this on to someone who you think may not know. Someone who could benefit from knowing how credit cards help build credit. And don’t be so sure that everyone you know would know this. Both my brother and friend are highly educated people who just happen to not know much about how credit cards build your credit.
The truth is that you can (and should) pay off your credit card every month. You don’t build credit from carrying a balance. All you do by carrying a balance and paying the minimum payment due is pay interest to the credit card company. Paying the minimum balance due and carrying a balance does not help you build credit.
You build credit with credit cards by using your credit card, getting a bill that shows a balance due, and paying it off in full.
Here’s why – your FICO score includes several variables, one of them being your credit utilization. Your credit utilization is the percentage of the amount you owe relative to the amount available. The amount you owe is typically what you spend throughout the month even if you pay it off in full. The amount available is your maximum credit limit.
The higher the percentage, the worse effect it has on your credit. The lower the percentage, the better.
For example, if you have a $10,000 credit card limit and you spend $2,000 / month and pay it off completely every month, your credit utilization is 20% ($2,000/$10,000). If you spend $9,000 of your $10,000 limit, then your credit utilization is 90%. The person who only spends $2,000 of the $10,000 available is deemed to be more credit worthy and financially responsible because she is not using all of the available credit.
- Related: How to get out of credit card debt
If you spend a lot on your credit card, consider getting a higher limit so that your credit utilization is lower. Of course, don’t increase your spending when you do this!
The Bottom Line
It’s a myth that you need to carry a balance on your credit card to build credit.
The truth is that if you pay off your credit card every month, you can build good credit. You build your credit with credit cards by keeping a low credit utilization. This means that you want to spend a small percentage of the amount available to you.