A zero-balance credit card can impact your credit score, and here’s why.
Too many financial consumers don’t understand their credit scores, and that’s a scenario that can lead to negative outcomes.
Data from GoBankingRates.com shows that 40% of Americans don’t know their credit scores. Additionally, a third of U.S. adults didn’t know what credit score level was necessary for securing a good mortgage, auto, or personal loan.
One area where credit scores are particularly vexing for consumers is when zero balances on credit cards come into play. Here’s everything you need to know about how a zero balance impacts credit.
How having a zero balance affects your credit score
At first look, one might think fully paying a card balance down to zero dollars would be a net positive. That, however, may not be the case with credit scores, which places a priority on how credit cards are used by financial consumers.
“A zero balance means an inactive account, which helps your score in the short run but poses risks long-term for your credit health,” said Kevin Haney, a former executive with Experian and president of Growing Family Benefits in East Brunswick, N.J. A zero balance lowers your revolving utilization ratio initially, which the scores use to identity consumers on the brink of financial trouble.
“People about to become delinquent often charge their cards to the limit, so lowering this fraction shows stability,” Haney says. “However, banks tend to respond to inactive accounts in ways that could hurt your score down the road. They might lower the limit or close the account.”
To find the best credit card that will get you on the path to a great credit score, visit an online marketplace like Credible, where users can compare all kinds of credit cards within minutes.
FICO SCORE VS. CREDIT SCORE: WHAT’S THE DIFFERENCE?
What is credit utilization?
Credit utilization is an important calculation tool for credit scoring agencies and a big metric for lenders and creditors. For consumers, that means hitting the credit utilization “sweet spot.”
“With a weighting of 30%, your credit utilization ratio is a key factor used to calculate your credit score,” said Richard Best, a credit specialist at Dontpayfull.com, a consumer discount financial spending platform. “Generally, your credit score improves when your credit utilization is less than 30% of your total available. The lower the better.”
Credit Utilization is one of several key factors credit agencies use when calculating consumer credit scores. Best notes the following factors, too.
Your payment history, which includes your on-time or delinquent payment record, accounts for 35% of your score.
The length of your credit history accounts for 15% of your score. The longer your credit history, the better.
Adding new credit can reduce your score, although the weighting is only 10%.
Your mix of credit can also affect your score. Heavy reliance on consumer-finance debt can lower your score. This factor weighs in at 10%.
Credit utilization accounts for 30% of an individual’s credit score and an individual’s credit score depends heavily on where his or her credit utilization stands.
“Having a zero balance on a credit card can help and hurt your credit score – depending on the situation,” said Jonathan Hess, founder of Hess Financial Coaching, a personal financial services and training company. “Having a zero balance helps to lower your overall utilization rate; however, if you leave a card with a zero balance for too long, the issuer may close your account, which would negatively affect your score by reducing your average age of accounts.”
WHAT IS SUBPRIME CREDIT SCORE?
How to boost your credit score
Consumers can take specific steps to improve their credit utilization ratio (and improve their zero-balance credit card picture) and strengthen their credit score overall. These five tips can get credit consumers on the right track.
Make periodic, small purchases on credit cards
Pay bills on time
Always know your credit score
Do some credit housecleaning
1. Make periodic, small purchases on credit cards: Instead of allowing a credit card balance to fall all the way to zero, try making small, periodic payments to boost credit utilization ratios. “That can help build your payment history, so long as you’re paying off the full balance each month and ensuring you’re keeping track of your credit utilization and cash inflows,” said Angelo Alessio, vice president of Product at Harvest
If you’re in the market for a new credit card, you can use Credible to see what types of cards are available to borrowers with your credit score.
2. Pay bills on time: On-time payments are the single best method for improving your credit score. “Maintaining a low credit card balance and overall debt-to-income (DTI) ratio is also important in ensuring you have a high credit score,” Alessio said.
3. Always know your credit score: You can’t improve your score if you don’t know what it is, and you don’t track its direction. “By law, you can receive a free credit report from each of the major credit reporting agencies once a year,” Best said. “You can also order free credit reports from AnnualCreditReport.com.”
THE FASTEST WAY TO INCREASE YOUR CREDIT SCORE
4. Do some credit housecleaning: The vast majority of credit reports contain errors, like misapplied payments, incorrect credit limits, and even wrong Social Security numbers. Any of those errors can drag credit scores down. “By law, the credit bureaus must correct errors,” Best added. “Once corrected, you can see your score improve instantly.”
5. Build your credit history: The biggest weighting of credit score health is the use of credit. “You must be able to demonstrate a constant record of on-time payments,” Best said. “To do that, use your credit cards regularly, but be sure to pay off the balances monthly.”
This article was first published on the Fox News Business website.
The article has been edited for clarity.