Few things in this world are more confusing than credit cards—how they work, what they really cost and how to manage them responsibly. While it’s only my opinion, I think credit-card issuing banks are just fine with that.
But I’m not fine with that and you shouldn’t be either! When it comes to credit cards, ignorance is not bliss.
What’s the solution? Stop being ignorant. Learn all you can. Ask questions in order to grow your financial intelligence. That’s the way to win the credit-card game.
Dear Mary: I am on the fast track to paying off my credit-card debt in full and forever. I’m like a racehorse heading into the final lap. Here’s my question: Does it matter when I make my monthly credit-card payments? Would it make any difference if I paid earlier in the billing cycle rather than just before the due date? Kevin
Dear Kevin: Wow, this is great news and I’m out here cheering you on. The answer to your question is Yes, it does matter. Here’s why:
Because you are carrying a revolving balance (as opposed to paying the balance in full each month during the grace period), interest is calculated on your average daily balance. At the end of every day, your credit-card issuer looks at your outstanding balance, multiplies that number by your annual percentage rate (APR), then divides by 365 (some use 360, but the difference there is minuscule) and then adds that amount (interest) to your outstanding balance. This happens every single day.
The sooner you make your payment, the sooner your average daily balance drops, the less interest you’ll be charged the following day. Now, more of your payment will go toward reducing the principal balance.
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Dear Mary: Thank you for all the research and advice you put out every day! My question: I have just qualified for a $10,000 credit limit on a Capital One credit card. I didn’t expect to be granted that much. Will it reflect poorly on my FICO score if I request a reduction to $5,000? Deena
Dear Deena: Credit scoring doesn’t consider credit limits, per se. What it looks at is your “utilization rate”—the amount of your available credit you are using at any given time. Utilization rate is another word for “debt.” Remember this: The higher your utilization rate, the lower your FICO score.
Let’s say you have a credit-card account with a limit of $10,000 and you are using $9,000 of it (a nice way of saying you’re $9,000 in debt). Your utilization rate is a whopping 90%.
On the other hand, let’s say you have an account with a $5,000 limit with a $0 balance. Your utilization is 0%, which is as perfect as it gets.
FICO looks at both your individual credit-card accounts and also your total credit-card picture—total credit limit vs. total debt. If you have two credit-card accounts and the utilization rate on one is 100% and the other 0%, FICO will consider your overall utilization rate to be 50%.
FICO’s Rule of Thumb: Keep your utilization rates below 30%—both individual accounts and overall, at all times.
Mary’s Rule of Thumb: Do not carry credit-card debt. If you can’t pay the balance in full every month get rid of that card (just don’t close the account until it’s at $0).
Now, back to your question: It all depends on how you manage this credit limit, be it $5,000 or $10,000. If your plan is to charge a $5,000 item (please tell me you’re not planning to do that), a $5,000 credit limit means you’ll have a 100% utilization rate. That will kill your FICO score, in which case the $10,000 limit with 50% utilization would be the better choice (although dangerous).
Once you understand utilization rates, you’ll be able to make a reasoned decision. Just keep in mind that the bank wants to push you into the $10,000 limit and then watch you max it out so you’re in debt up to your eyeballs forever. Been there.
There is a common belief out there that a credit score (FICO is only one of many brands of scores) should be called a “debt score” because the more debt you have the higher your score will be. That is simply not true—a prevailing myth that needs to be put out of its misery.