Modern adult life all but requires us to borrow money for something or other, and your credit score is getting ever more important. It may one day literally determine your social standing and which friends you hang out with, as with what’s happening in China right now. But there are so many myths that surround debt: Does it actually boost your credit score? Should you try to have a little bit of debt? How do you even get this so-called “good” debt? With the help of Frank Kriticos, a credit expert and radio host with San Diego Credit Solutions, we’re here to explain it in a way that (mostly) won’t make your head hurt.
So does having debt boost your credit score?
Well, not really. It’s good to have a few lines of credit, but actually carrying debt will hurt your credit score. Kriticos points out that there’s a crucial difference between revolving debt (credit cards) and installment loans (auto loans, mortgages and things with set terms). FICO, the credit score agency, won’t ding you for maxing out your installment loans, as that’s what most people do for the term of the loan. But FICO will ding you for approaching your limit on revolving lines of credit.
Like if you max out your credit card?
Yes. But you don’t even have to max it out. In fact, Kriticos says, your score will be affected even if you go beyond 10 percent of your limit (this proportion is called the debt-utilization ratio). “It’s all about the utilization rate — it has nothing to do with the dollar amount,” he says. So whether you spend beyond $1,000 on a $10,000 line of credit, or $10,000 on a $100,000 line of credit, anything beyond that rate will gradually affect your score. So between 10 and 30 percent will ding you a little bit, between 30 and 50 percent will hurt your score a little more, and so on. Maxing out your card will hurt your score big time, he says.
So cards with high limits are good?
Correctamundo. Kriticos says to beware of cards with low limits, like $500. A couple trips to Costco alone will max you out.
Okay, but how many lines of credit should I have?
“FICO likes to see anywhere between two and five revolving lines of accounts on a credit profile,” Kriticos says. However, that’s kind of a rule of thumb, and should depend more on your current credit score. For example, if you have, like, 15 credit cards and a great credit score of, say, 750, and everything’s good, Kriticos says you shouldn’t start canceling 10 of them.
What am I supposed to do with five credit cards?
Well, the reason you want to have several revolving lines of credit is for more credit history. So here’s where a little debt is good, rather than a zero balance. If you have a tiny bit of debt on a card, the creditor is less likely to close your account (something that can happen due to inactivity), which is bad for your credit score, because when a creditor closes your account, you lose all that credit history.
But when we say a little debt, it can mean just a single purchase. Kriticos says he has three credit cards: He keeps two at home and one in his wallet. Once every three to four months he’ll charge a cup of coffee or a tank of gas on his other two cards. As long as creditors see a bit of activity on a card, they probably won’t close it on him.
What’s up with those people who have no debt and pay for everything in cash or on their debit card? How’s their credit?
“That [approach to spending is] good from a financial standpoint — but what makes financial sense doesn’t make credit sense,” Kriticos says. “The logic isn’t the same, and that’s important to know.” Idle cards don’t hurt your score, but closed accounts do — because, again, all that credit history is lost when an account closes. If somehow you’ve never borrowed money, you likely have no credit score. Which also makes it tough to get a loan when you need one.
So… debt is good? Kinda?
Well, sorta. In the larger picture, beyond your credit score, credit experts consider “good debt” to be investments in things that will benefit you — like education, or a car if you need it to make money, things like that (an example of “bad debt” would be taking out a payday loan). When it comes to your credit score, you don’t need debt to have good credit, Kriticos reaffirms: It’s not the dollar amount, it’s the activity and keeping your debt-utilization ratio in check.
What if I pay off my credit card balance every month?
Okay, this is a bit complicated. You can pay it off, but depending on your debt-utilization ratio, you still might get dinged. The key is paying it off early in the month if at all possible. “If you pay it by the statement date, then the highest balance is gonna be reported to the bureaus which, as a result, will lower your score,” Kriticos says. “The key is to pay off your balance by the billing date. Every creditor has a different billing date, but by default it’s two weeks before the statement date. If you pay it off by then, the zero balance will be uploaded to the bureaus and you’ll have a zero balance. But if you pay off the card in full every month by the date that’s on your statement, then it’ll look maxed out on your credit report.”
If you’ve never heard of the billing date before, you’re not alone — although they’re not exactly a secret, credit cards don’t go out of their way to advertise them. The billing date is an arbitrary date (each creditor has its own) where the creditor reports every one if its debtors’ balances to the credit bureaus. You can find out yours, Kriticos says, by calling up your credit card and just asking them, what day of the month do I have to pay in order to have a zero balance?
Even if you can’t make this for whatever reason, paying off your balance at any time is never really a bad thing, because credit card interest rates suck.
I want to pay off my credit card, but that’s easier said than done. Is there a way that will boost my score and not kill me financially?
Glad you asked: Kriticos says to give yourself a personal loan, which you can do through lots of different websites (you get a lump sum of money that you use to pay off your card, after which you pay back the personal loan lender). Since a personal loan is considered an installment loan (like an auto payment or mortgage), FICO won’t penalize you for this. Kriticos didn’t want to steer people toward any specific one, but they’re readily available. Just Google it.
So… debt is good then?
Sigh. Just a little bit is good, but again, the correct utilization ratio of it is key. Just remember to keep your card collection minimal, and your credit limit high.
Adam Elder
Adam Elder is a writer in San Diego. He's also written for Esquire and WIRED magazines, VICE, The New York Times, The Wall Street Journal, The Guardian, newyorker.com and elsewhere.
