If you’re anal like me, you probably pay off your credit card online immediately after your come home from shopping so that you won’t forget. Because the thought of incurring interest fees and giving free money to the credit card companies is insane to you and you’d rather be paying off credit card debt fast.
You are very strict about not paying those companies any interest from any remaining balances so you ensure your balance is at $0 all the time.
I’m here to tell you that you are wrong! Today, I will discuss how to pay off credit card debt correctly.
Paying Off Credit Card Debt
Having a $0 balance is good, but not the best for your credit score. The reason behind this is that credit companies will collect your utilization percentage once a month. And this comes from your monthly credit card statement.
You know when you get that e-mail/message that says “Your Credit Card Statement is Now Available”?
THAT is when credit bureaus get your credit card information and that balance is reported to the credit bureaus.
If your statement balance is ZERO because you paid it off already, credit bureaus will see ZERO, meaning you didn’t even use your card this month!!
This is not how you want to be paying off credit card debt. That is to say, if you’re using your credit card for purchases, you might as well be building up your credit score while you’re doing it.
This utilization is what affects your credit score. It’s good to maintain a low utilization rate to have a better credit score but a utilization of 0% could indicate to the creditors that your credit card is inactive.
Your utilization rate is dependent on your current balance divided by your total credit. If your Visa has a limit of $1000, and you have a balance of $500 come statement time, then you will be reported as having a 50% utilization rate.
Having a balance of $500 on a credit card with a credit limit of $1000 is still better than having a balance of $9000 on a card with a $10000 limit. (50% versus 90%).
As a general rule, keeping your utilization rate between 1% and < 30% will benefit your credit score the most.
When should you pay off your card?
Let’s assume your credit card company sends you your statement balance on March 15 with a payment due date of April 10. There are three time periods in which you can be paying off credit card debt.
- Before your statement balance. This time period would be before March 15.
- After the payment due date. This would be after April 10.
- The time period from when you receive your statement balance to the payment due date. This time period is between March 15 and April 10.
Additionally, let’s assume the following:
Credit Card balance: $0
Credit Card Limit: $2000
Paying Off Credit Card Debt: Scenario 1
On March 1, I go out and buy a TV for $1,000. I pay it off as soon as I get home by transferring money from my bank account.
On March 15, my statement balance comes out and it’s $0. The credit bureaus collect this information and report it as a credit utilization of 0%.
In their eyes, it’s like I never used my credit card! This doesn’t help my credit very much.
Paying Off Credit Card Debt: Scenario 2
On March 1, I go out and buy a TV for $1,000.
On March 15, the statement balance comes out and it shows that I have a balance of $1,000. Since my credit card limit is $2,000, this gets reported to the credit bureaus as having a utilization rate of 50%.
This is pretty high! My credit score drops because of the sudden huge increase in utilization.
I pay off the $1,000 and my balance goes back to $0.
It’s not until the next statement balance on April 15 when my credit bureaus see my utilization of 0% and then restore my credit score back. Although it may take some time.
Paying Off Credit Card Debt: Scenario 3 – THE BEST SCENARIO
On March 1, I go out and buy a TV for $1,000. When I get home, I log onto my banking website and pay off only $800. On March 15, my statement comes out and it shows I have a balance of $200.
My maximum credit is $2,000. The credit bureaus see this as me having a 10% utilization rate. This is a great rate!
Certainly better than 50%.
So after I received my statement, I pay off the remaining $200 and start off the next month with a $0 balance again.
Rinse and repeat.
In conclusion, it’s easy to manipulate your payments to maximize your credit benefits. As seen in SCENARIO 3, optimizing your credit involves keeping your credit balance to a minimum by the statement date. Remember to keep your utilization low by statement balance time (but not zero) and to pay off your balances before the next statement balance cycle comes as that’s when interest is applied.
By the way, be sure to sign up at www.creditkarma.com for free credit reporting and credit scores. They’ve launched this free service in junction with Google to provide free credit reporting to everyone after a year of launching.
Additionally, don’t forget to strategize your debt payments. Remember Step 2.