Understanding how credit card balances affect your credit score can be somewhat difficult to comprehend. There are certainly many misconceptions and much misinformation that are circulated among consumers, mostly coming from friends and family that mean well, but don’t really understand how credit scoring works.

One of the most misunderstood pieces of the credit scoring puzzle is how credit card balances affect the credit score. The credit bureaus typically add and subtract points based on the total balance relative to their respective credit limits. In other words, the percentage of the credit limit used is often more important than the actual amount owed on the account. The credit bureaus tend to add or subtract points based on a tiered scale that changes whenever the balance goes over or under 25% incriments. So having a credit card with a balance over 25%, 50%, 75% or 100% of the limit will trigger changes in the credit score.

As an example, let’s assume you have a credit card with a balance of $600 and a limit of $1000. The balance is 60% of the credit limit. Since that’s over 50%, it will tend to lower your score. Suppose you pay $200 on the account, dropping it to below 50% of the credit limit. This would raise your score, and probably quite a bit in most situations (credit scoring models take many different factors into account, and the amount of the increase will depend on other factors). However, if you piad $400 on this account, the credit limit would drop to below 25% of the credit limit, which would raise the score even more than just paying it down to 40% since you’ve dropped it below another one of the 25% benchmarks.

On the other hand, if you ran up the balance to $800, that would tend to lower your score even more since you pushed the balance above the 75% mark. And if you maxed out the card to over the limit? That could cause your credit score to drop substantially.

So the bottom line is that you need to make an effort to target the balance where it’s under 75%, 50% or 25% of the credit limit. The lower, the better.

HERE’S ONE IMPORTANT THING TO REMEMBER!
Don’t assume that paying off your credit cards every month will mean the credit bureaus calculate your score with a zero balance. Credit card companies only report to the credit bureaus once a month, and this tends to be at times when the balance is at or near the high point of the month (close to or on the day the billing cycle ends). So if you happen to run the balance of your credit cards over 50% of their limits in any given month, there’s a good chance that balance will be the one that is shown in your credit file. So it’s a good idea to ALWAYS try to keep the balance at or below 50% of the credit limit, even if you plan to pay down the balance when the bill comes. Quite simply, you have no control over when your credit card company will report the balance to the credit bureaus.

Credit card balances are just one of the many factors that determine your credit score. The most important factor is your payment history, so don’t ever miss a payment on an account in order to pay a large payment on another account in hopes that this will raise your score. The damage caused by the late payment can be far greater than any improvement you will see from paying down a credit card.

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If you are the type of person that is afraid to use credit cards because of past credit issues, or maybe you can’t even get a credit card because of those issues, a secured credit card may be a great alternative that will allow you to enjoy all of the advantages of credit cards without having to worry about your credit card debt getting out of control.

In this day and age, it seems we are conducting more and more transactions over the phone and the internet that require credit card numbers. The reason for this is simple. Literally. Credit cards simplify our lives in many ways. They allow us to save a great deal of time and they are super convenient. Why bother leaving the comfort of your home when you can shop, view and compare products online?

But many people have reservations about using credit cards for many reasons. Many have gotten themselves into trouble in the past with high interest debt or they can’t get approved for a credit card because of past credit issues. A secured credit card solves both of these problems! Secured credit cards are available to almost anyone regardless of past credit issues. And since the credit limit on a secured credit card is limited to the amount of security deposit that you are willing to put up as collateral, there’s no need to worry about balances getting out of control. And the interest rates on secured credit cards are often more competitive than unsecured cards for the simple reason that the bank is much less likely to lose any money since the card is “secured” with a cash deposit.

Aside from the convenience aspect, credit cards provide a higher level of consumer protection than any other form of payment, even debit cards. Think about it. If someone steals your debit card, that’s money that comes directly out of your checking account whereas a credit card is not tied to living expenses. There’s no risk of bouncing checks or being short on cash. Most banks will also not extend the same level of protection to consumers for transactions made on their debit card. For example, I recently had a dispute with an internet merchant who overcharged me for a service. Unfortunately, I charged this on my debit card, which meant I was left to fend for myself against the merchant. If I had charged this on my credit card, the card issuer would have removed the charge and helped me dispute this with the merchant. I got lucky and was able to get my money back, but it took almost six months. I learned the hard way that using your debit card for internet purchases can pose many problems. Credit Cards offer a level of protection higher than any other form of payment.

Learning how to use credit cards for their benefits without falling into the trap of compound interest is the tricky though, and many people do not have the financial self-discipline to do that. The smart way to use credit cards is to pay the full balance every month whenever you can. A good rule to live by with credit cards is only charge what you can afford to pay at the end of the month.

Keeping active accounts on your credit report is crucial to maintain a good credit score. Many consumers who have run up lots of credit card debt in the past cancel all of their credit cards in an effort to “rid themselves” of the temptation to get back into financial trouble. While this can be a good strategy, canceling credit cards can drastically lower your credit score since a significant portion of the score is determined by active accounts and the length of time accounts have been established. Simply canceling all credit cards can be a mistake that can result in a lower credit rating. It’s better to keep some accounts open and ask the creditor to lower the credit limit if that’s a problem.

Secured credit cards are the best way to maintain a good credit rating and enjoy the various benefits of having a credit card while still maintaining responsible spending habits.