Consumers with subprime credit scores are about three times as likely to be “revolvers” as those with prime credit scores, according to a study by the American Bankers Association. Revolving is a term for carrying a credit card balance from month to month instead of paying in full.
Here were the percentage of consumers who were revolvers in each credit score group:
- Subprime (below 680): 90.2%
- Prime (680 to 779): 68.5%
- Super-prime (780 and above): 27.3%
That’s a significant difference with each group. Once you understand how carrying a credit card balance can affect you, it will make sense why the most credit-savvy consumers try to avoid it.
The dangers of carrying a credit card balance
With credit cards, you save money by paying the full statement balance every month. If you do, then you won’t be charged any credit card interest on your purchases. If you carry a balance, then the card issuer can charge interest on it.
It’s not just interest charges that make carrying a balance dangerous. It’s getting into the habit of spending more than you can pay back and gradually falling deeper into credit card debt.
For example, let’s say you start with an unpaid balance of $500 one month. On a card with an 18% APR, that would cost you about $7.50 in interest. You’re not paying much extra at that point.
But the next month, you have another $300 you can’t pay. You’re now carrying an unpaid balance of $800, and the card issuer tacks on $12 in interest. If you let this become a habit, you’ll go further into debt, and it will cost you more money.
Credit card debt statistics show us how common that is. The average card balance was over $6,000 in 2019. That much debt hardly ever comes from one $6,000-plus purchase. It usually comes from carrying a balance that gets bigger month after month.
Carrying a balance can lower your credit score
In addition to credit card debt, carrying a balance can also hurt your credit. A large part of your credit score depends on your credit utilization ratio — your credit card balances divided by your credit limits.
The rule of thumb for credit utilization is that lower is better, and it’s recommended to keep your credit utilization below 30%.
If you’re carrying a $750 balance on a card with a $1,000 limit, your credit utilization would be 75%. Since that’s on the high side, it would negatively impact your credit score.
This is another reason why it helps to pay off your credit card consistently. You won’t run the risk of accumulating a large balance that causes your credit score to drop.
How to use a credit card
Credit cards allow you to pay off purchases over time, but that’s not the best way to use them. It’s better to stick to a budget and always pay the full statement balance.
When you do that, you get all the benefits of making purchases by credit card, such as earning rewards and getting complimentary purchase protections. And you don’t need to pay anything extra in the form of interest charges.
There is one exception, and it’s 0% APR credit cards. These cards charge no interest on purchases for an introductory period. If you need to pay for something expensive and you can’t cover the entire cost upfront, then this is the type of credit card you should use. Even with a 0% APR card, aim to pay off the balance as quickly as possible so it doesn’t cost you money when the introductory period ends.
Payment habits are an area where there’s a stark difference in consumers with the highest and lowest credit scores. If you’re new to credit, it’s worth following what consumers with super-prime scores do and pay your balance in full. And if you’re currently carrying one or more balances, start planning how you can get out of credit card debt and stay out of it in the future.
View more information: https://www.fool.com/the-ascent/credit-cards/articles/consumers-with-low-credit-scores-are-3-times-as-likely-to-have-this-costly-financial-habit/