Dear Credit Card Adviser,
I have a question regarding payment to credit card bills. I'm a new college student, age 22. During this year, I was having a difficult time getting a credit card by my own means simply because of lack of credit history. Two months ago, I began applying for credit cards online until I got a response from a card company from Discover. I was shocked that I got accepted, yet I am still trying to figure things out about how credit score works. I've been using my card for only necessary things like gas and groceries. I was doing some research online about credit cards and the best way to take a responsible use of credit card and staying within credit limit. And I came across your blog, and these are my questions:
How does credit score really work? Is it best to pay off my credit card balance in full or make minimum payments? Does making minimum payments hurt your credit score in the future?
Paying your credit card balance in full is smart financially, but it won't improve your credit score directly. Neither will making the minimum payment, by itself, harm the score. Let me emphasize that -- you don't get any points for paying interest or paying in full. People who tell you they are "keeping a small balance to help my score" are paying interest foolishly. Your credit score is based on your credit report, and whether you carry a balance or not isn't noted on your report.
Your balance will appear on your report, though, and that can affect your credit score. In fact, the proportion of available credit currently being used on revolving accounts is a heavily-weighted component in the FICO score, a credit score that many lenders use. A high debt-to-credit limit ratio, or utilization, can result in a lower score.
Where paying only the minimum would hurt you is if you had a high balance that wasn't decreasing much each month. Paying more than the minimum would reduce the balance that reflects in your utilization, which should have a positive effect on your credit rating.
To keep a low utilization ratio, use your new credit card lightly. Paying in full doesn't necessarily hide a high balance charged with your credit card.
MyFICO.com explains that "even if you pay your credit cards in full each month, the balance shown on your credit report may not be $0. Instead, it will reflect your account balance at the time your lender supplied the update to the credit reporting agency."
Bottom line, I think it's best to pay on time and in full while keeping monthly balances low. This strategy keeps you out of debt and helps to build a good score over time. Experts disagree over the threshold to keep monthly balances under, but in general, the lower your utilization is, the better.
For more tips, read this previous column on improving your credit score.
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