
Credit Reporting
How Carrying a Balance Could Affect Your Credit Score
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Did you know that 43% of Americans are carrying a balance on a credit card, and nearly 56 million cardholders have been carrying that balance for over a year?
While you may find yourself in this situation at some point in your life, it's essential to understand that carrying a balance may have a big impact on your credit score—a critical factor that lenders often consider regarding applications for loans, credit cards, and other financial products (it may even affect your ability to rent an apartment or secure a cell phone plan!)
If you're carrying a balance and wondering why your credit score may have dropped, this overview can help explain why that may happen and provide some strategies for helping to regain control of your financial future.
And if you need to establish or help in rebuilding your credit, Varo has a secured credit card option that can help you do exactly that!
Meet Varo Believe, our secured credit card with no annual fee, no credit check, no interest, and no minimum security deposit. On average, customers using the Believe card see a 40-point increase in their credit score after 3 months of on-time payments.2
What is a Credit Score and How Does it Work?
Your credit score is a number between 300-850 that represents your creditworthiness or how likely you are to be able to repay borrowed money. Lenders, such as banks and credit card companies, often use your credit score to assess the risk of lending you money.
A higher credit score can often indicate that you're a lower-risk borrower, which could lead to more beneficial loan terms, lower interest rates, and even higher approval odds.
Several factors influence your credit score, but the two most prominent are:
1. Payment history (35% of your FICO score): This factor indicates how well you've done at paying your bills on time. Late and missed payments as well as collections could significantly damage your credit score.
2. Credit utilization (30% of your FICO score): This is the percentage of credit you use compared to your available credit limits. High credit utilization—especially above 30%—could signal that you’re unable to meet your current financial obligations, which could in turn, lower your credit score.
Other factors that impact your credit score include:
Length of credit history (15%): How long you've had credit accounts open
Credit mix (10%): The variety of credit types you have, such as credit cards, mortgages, and auto loans
New credit inquiries (10%): The number of new credit applications you've made recently
How Carrying a Balance on a Credit Card Could Affect Your Credit
Carrying a balance on your credit card means you have yet to pay off your full statement balance by the due date (typically 21 days after the statement has closed.) In these cases, your remaining balance is carried over, and you're charged interest on that amount.
While carrying a balance might seem mostly harmless, it could impact your credit score.
One of the main ways carrying a balance could affect your credit score is through your credit utilization ratio.
This ratio is calculated by dividing your total credit balances by your total available credit limit. For example, if you have a $1,000 balance on a credit card with a $4,000 limit, your credit utilization ratio for that card is 25%.
High credit utilization, particularly above 30%, may negatively impact your credit score because it could suggest to lenders that you may be financially overextended and possibly even struggling to manage your debt. Maintaining a low credit utilization ratio, ideally below 10%, could help improve your credit score over time.
There's a common myth that carrying a small balance on your credit card can help your credit score. This may not necessarily be true. The Consumer Financial Protection Bureau (CFPB) outlines that paying off your credit card balances in full each month may be the best way to keep your credit in good standing.
Example of How Carrying a Balance Can Impact Your Credit Score
Let's say you have a credit card with a $1,000 limit and regularly carry a balance of $800, resulting in a credit utilization ratio of 80%. This high utilization could significantly lower your credit score.
On the other hand, if you pay down your balance to $200 (20% utilization) or even $100 (10% utilization), you could see a noticeable improvement in your credit score over time.
Remember, while carrying a balance on your credit card might seem like a normal part of managing your finances, it could lower your credit score. You can work toward a healthier credit profile by understanding how credit utilization works and striving to pay off your balances in full each month.
The Consequences of High Credit Utilization
When your credit score takes a hit, it could impact your ability to access credit in the future. Lenders may view your credit as higher-risk, which could make it more difficult to secure loans, mortgages, or additional credit cards with more favorable terms.
If you're applying for a mortgage with a low credit score due to high credit utilization, for example, you could face higher interest rates or even be denied altogether.
A low credit score resulting from high credit utilization could also affect other aspects of your life, such as:
Renting an apartment: Landlords often check credit scores to assess potential tenants' financial responsibility.
Getting a cell phone plan: Cell phone providers may require a security deposit for those with lower credit scores.
Applying for a job: Some employers, particularly those in the financial sector, may check credit reports as part of the hiring process.
Consumers with good credit and a FICO Score between 670-739 generally have a credit card utilization of about 35.2%.
Missed Payments and Credit Scores
In addition to high credit utilization, missed payments could also have a significant negative impact on your credit score. Payment history may be one of the most crucial factors in determining your credit score, often accounting for 35% of your FICO score.
When you miss a credit card payment, your lender may report it to the credit bureaus as a delinquency. This payment delay could stay on your credit report for up to seven years, which could lower your credit score and make it more difficult to access credit in the future.
Even a single missed payment could cause a substantial impact to your credit score. For example, if you have a credit score of 780 and miss a payment by 30 days, your score could drop by as much as 90 to 110 points, according to FICO.
To avoid missed payments and protect your credit score, it may be helpful to consider setting up automatic payments from your checking account to ensure you pay your bills on time each month.
5 Strategies for Paying Off Your Credit Card
If you're currently carrying a balance on your credit card, don't worry—there are strategies you can implement to help pay off your debt and improve your credit:
1. Create a Budget
Analyze your income and expenses to identify areas where you can cut back and allocate more money towards debt repayment. Many people who successfully budget create a separate savings account specifically for paying off their credit card debt.
2. Consider the Debt Avalanche or Debt Snowball Methods
The debt avalanche method involves paying off your highest-interest debts first, while the debt snowball method focuses on paying off your smallest debts first for a motivational boost.
3. Look Into Balance Transfer Credit Cards
Many credit cards offer a 0.00% introductory Annual Percentage Rate (APR) period. By transferring your credit card balance from a high-interest card to one with no interest, you may be able to pay them off without accruing additional interest for the length of the introductory term, which is usually about 15 months.
4. Explore a Personal Loan
Personal loans generally have lower interest rates than credit cards, which could result in a potential reduction in the overall debt burden and savings on interest charges in the long run. Therefore, by consolidating all the credit card balances into one personal loan, you could simplify your repayment plan by having just one fixed monthly payment by combining your debts into one payment.
5. Negotiate With Your Credit Card Issuer
When contacting the credit card issuer, you could discuss options such as reducing interest rates, creating a repayment plan, or even settling the debt for less than the full amount owed. For a positive outcome, it's important to be prepared with information about your own individual debt, understand the available debt relief options, and communicate your unique financial situation and needs.
Building and Maintaining Good Credit Habits
Developing good credit habits can be essential for long-term financial health. Some key habits to adopt may include:
Paying your bills on time, every time
Keeping your credit utilization low by paying off balances and avoiding maxing out your available credit
Monitoring your credit reports regularly and disputing any errors
Being selective when applying for new credit to minimize hard inquiries on your credit report
Maintaining a healthy mix of different types of credit (e.g., credit cards, installment loans) to demonstrate your ability to manage various forms of debt responsibly
By incorporating these habits into your financial routine, you can work towards building and maintaining strong credit health over time.
Finding a Strategy That Works For You
Carrying a balance on your credit card could potentially bring down your credit score, primarily through high credit utilization. But, you can work toward a brighter financial future by understanding how credit scores are calculated and adopting strategies and tools (like the Varo Believe Card1)..
Financial freedom is possible. Finding a payment strategy that works for your unique situation can be just a matter of time and diligence. Soon, you can be well on your way toward reduced or eliminated credit card balances and healthy credit.
¹ Varo Believe is a secured credit card designed to help you build credit; however, a variety of factors impact your credit and not all factors are equally weighted. Building credit may take time and Varo Believe may be able to help when you consistently make on-time payments.
² Customers who had an existing VantageScore® 3.0 credit score showed an average VantageScore® 3.0 score increase of approximately 40 points after three months of having Varo Believe and no late payments on their credit. Individual results may vary, and some customers may not see a score increase. As of July 3, 2024.
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