When You Pay Matters

Jan 27, 2015 by

CalendarYou’ve heard this over and over: to help maximize your credit score, pay off your credit card balances in full and on time every month.

Sounds logical, but like many conventional wisdoms, it’s partly wrong!

The Standard Advice About Paying Credit Cards

Based on common financial sense and what you read on the always expert Internet (yeah, right!), you might pay off your credit card balances in full every month. That’s smart—interest expense is perhaps the single household cost with no offsetting benefit.

The thinking goes like this:

  1. Never pay interest or late payment fees to the credit card company, but also
  2. Don’t turn over your money any sooner than is necessary to meet #1

These add up to paying in full, but not until you have to, perhaps on the payment due date or the day before.

Yep, this will keep you from wasting money on interest and fees, and will keep your money working for you as long as possible. And compared to paying late or less than the full balance, your credit score will thank you.

But if you want to boost your credit score even further, there’s a better way to handle credit card payments.

Credit Utilization

As you know from my recent series here on optimizing your credit score, credit utilization, which accounts for 30% of your FICO® credit score, means the portion of your available credit that you’re actually using.

For example, if you have two credit card accounts with a combined credit limit of $15,000 and your combined balance on both is $8,000, your credit utilization is 53%.

$8,000 ÷ $15,000 = 53%

In general, your credit score falls as your credit utilization rises. People using much of the credit available to them are considered higher risk than people who are using little of their available credit. Makes, sense, overall and on average, I suppose.

So if you pay off your credit card balances in full each month, your credit utilization is 0%, right? WRONG!

Your Credit Score is a Snapshot of Your Credit Report

Remember: your credit score reflects the information on your credit report at a given point in time. It reflects a ‘quick & dirty’ snapshot of your credit report.

Let’s say a typical statement cycle for one of your credit cards runs from the 4th of the month through the 3rd of the following month. One month you go on a bit of a spending spree and put $4,000 worth of new kitchen appliances on your credit card. Your spree happens to take place on the 6th of the month—only two days into the statement cycle.

If you wait, say, 40 days until the payment due date for the current cycle to pay off the $4,000 (and whatever else you’ve charged during the cycle), your credit card account’s balance for nearly the entire current statement cycle— plus a good chunk of the next cycle—will be $4,000+. Sometime during that long period when your balance is at least $4,000 your credit card issuer will make its monthly report of your account’s balance to the credit bureaus. And that balance won’t be zero!

If your credit limit on the account is $6,000, your credit utilization for that account will be upwards of a hefty 67%. FICO’s not going to like that!

If you think about it, most of us almost always make purchases with our credit cards during the two weeks or so between 1) the date the statement cycle ends and 2) the date that cycle’s payment is due. That means the current balance on our accounts is never $0, even though we pay our balance in full each month.

→ When we make our on-time payment, our account balance falls to our cumulative purchases during the current cycle, not to zero.

How to Optimize Your Credit Score

Here are a few strategies to boost your credit score by changing the way you make credit card payments:

  • When you make a payment, pay the current balance, not the last statement balance. This will, until you make another purchase, reduce your account balance to $0. And it’ll cause your average balance over statement cycles to be less than if you routinely pay the statement balance.
  • If you make an exceptionally large purchase with a credit card, send some cash to your card issuer soon after the transaction, which may be long before the due date or even before you get the statement reporting the purchase.
  • For relatively large purchases, use a debit card!
  • This is risky if your discipline is poor, but ask your card issuer for a higher credit limit. If you don’t change your charging habits, your credit utilization would fall.

Like me, you might chafe at the idea of sending money to a credit card company any sooner than you have to. I understand. But let’s also think for a moment objectively, not emotionally, about what we’re giving up when we pay earlier than required: these days, interest on the amount of the early payment at the rate of something like 0.02%. That’ll add up to about 12 cents over the course of our lives.

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  • elisec

    So I called and asked my credit card company when they report to the credit bureaus. In the case of Discover (for anyone reading) it’s the first Friday after the closing date of your billing cycle. So if they issue you your statement on a Monday or even a Thursday – it’s still reported that Friday. (which is up to a week before your actual due date) So goal would be to pay it the second you get it (unless it falls on a Friday, in that case think ahead and still pay it the Thursday)

    My question: I got my card specifically to build credit I’ll never “need” it for that $4000 purchase you mention.
    Is it better to just have one and not touch it so it always reads zero, or is the sweet spot in racking up debt, and paying it before it’s reported so it’s also showing balances paid?

    • Payment History accounts for 35% of your FICO credit score–even more than credit utilization at 30%. So to optimize your credit score, it’s important to demonstrate a history of borrowing money and paying it back, on time. For your single credit card account, I’d suggest borrowing up to 10-15% of your credit limit, then paying it off according to the schedule you learned about from Discover (good for you!). You don’t necessarily need to do this every payment cycle; a few cycles a year should be good.

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