Chances are, you're more likely to gain access to Fort Knox than to discover the inner workings of credit-scoring algorithms. But just like we confidently know what goes into Fort Knox (gold), we know what data of yours is funneled into credit-scoring formulas.
All it takes is a quick online search to understand the broad pillars of good credit behavior. But that doesn't mean you'll always get the right information from every online site.
With this in mind, The Motley Fool analysts Michael Douglass and Nathan Hamilton answer a question in the video below about credit card debt and how it impacts your credit score, addressing a common myth that cardholders need to carry credit card debt to establish a better credit history. Understanding why carrying debt isn't required highlights one of the most important credit-scoring factors, credit utilization.
Michael Douglass: Bruce asks, "I'm carrying a balance on my credit card and I'm wondering if I need to continue doing so to improve my credit score."
Nathan Hamilton: No.
Douglass: Bruce, great question, the answer is no, absolutely not, and here's why.
Hamilton: There's a myth out there, and some people believe that you do need to carry a balance on your credit card and incur interest charges to improve your credit score. That's not the case. If you look at it, we have mentioned sometimes before, credit scoring formulas look at what's called credit utilization, your debt divided by your total available limit. The best credit utilization you can report to the scoring models is going to be 0%. So, you can run up your balance, pay before the statement date, and you are showing 0% credit utilization, which will get you one of the better credit scores out there. So, there's no need to carry debt to improve your credit score. There have been some -- it's not too much known at this point, but there's something called trended spending, where credit card issuers will track your spending trends, and may report that information. But, really, looking at it at a very basic level, no, you do not need to carry a balance to improve your credit score. You should not have to pay money to improve your credit score. There are too many no-fee solutions out there.
Douglass: In fact, if you are paying money to improve your credit score, that may be a bad sign.
Hamilton: Yeah, unless it's some debt consolidation services. There are some third party services and so forth. But, very basically looking at it, you're really not going to incur cost to improve your credit score.