Fact Check Finance: Having credit card debt can help raise your credit score
Fact Check Finance is an occasional series that puts common money assertions to the test.
“More than 1 in 5 credit-card users, or 43 million Americans, carry a balance—or pay the minimum to credit-card companies, thus always owing them money—to help improve their credit scores, according to a new report from CreditCards.com.”
—USA Today
When Dan, 29, got his first credit card after college, he thought the most important thing he could do was spend money with it. That’s how you build up credit, right?
He assumed that paying the minimum—all the while accruing interest—would simply show he was a dedicated cardmember who played by the rules, and that “having numbers on the statement” meant his credit score would go up.
When that score took a hit (see below for why), Dan realized his mistake. He isn’t alone. A widespread myth holds that paying a minimum on a credit card balance month to month is beneficial to building credit. According to a CreditCards.com survey last year, 22% of Americans deliberately employed this practice because they thought it would improve their credit—including 28% of millennials.
Gerri Detweiler, education director for Nav, a credit education service for small business owners, said that this financial urban legend may have its origins in the early days of the credit card industry. “This myth probably dates back to a time when there were more manual reviews of credit reports, and most people didn’t use credit, so building a payment history was important,” Detweiler explained. “But that’s a long time ago—and I still hear this from consumers frequently!”
What really matters
Tommy Lee, principal scientist at FICO, the leading credit scoring company in the U.S., agreed that this is among the biggest misconceptions about how scores are calculated, emphasizing that “carrying balances from month to month and not paying off a credit card balance in full—incurring interest fees—absolutely does not help the FICO score.”
Although consumers like Dan are often concerned with proving they’re actively using their lines of credit over time—sometimes leading them to leave an unpaid balance on a card—Lee noted that “the FICO score does not take into account info about whether a person is carrying a balance every month” on a credit card.
“What matters to the FICO score is keeping your balances reported in credit file relatively low in comparison to credit limit—and consistently making those payments,” Lee said. To make sure this happens, it never hurts to automate your monthly payments.
Not all debt is the same
One reason that those 28% of millennial consumers carrying a credit card balance are confused could be that they’re more familiar with another kind of debt payoff. Vera, 30, who recently completed a master’s in urban planning, wondered if this misguided approach might be derived from “the fact that carrying student loan balances and establishing a history of regular payments on them yields improved credit scores for many.” You don’t pay off your full student loan balance every month, the thinking goes, so why are credit cards different?
Detweiler noted the distinction between these types of debt. “Most personal loans [such as student loans] are reported as ‘installment’ loans rather than ‘revolving’ accounts,” she said. With a student loan, you pay fixed installments of your balance every month.
“The FICO score understands that consumers are not going to be able to pay off their entire installment loan” at once, Lee said.
However, meeting those monthly payments is key. If you make regular on-time payments, you’ll get a credit score boost; if you don’t, your score will suffer, and you could fall into delinquency on your loan, which can truly ruin your credit.
Fact check verdict
This one’s a no-brainer. Carrying a balance will reflect badly on your credit score and your wallet: the more you owe, the lower your score and the higher the interest you’ll need to pay back. If anyone tells you otherwise, tell them that myth’s been busted.
