Alex Pardoe, a 25-year-old hairstylist in Detroit, is pretty good with his money. He's built a successful business in the Detroit suburbs and is on track to earn close to $300,000 this year.
But he's fallen victim to a pervasive money myth that could hurt his overall financial health: Pardoe keeps a balance on his credit card because he believes it will improve his credit score, even though he has more than enough in his checking account to pay the $2,000 debt off in full.
It's a common misconception, Ted Rossman, industry analyst for CreditCards.com, tells CNBC Make It. A 2018 survey from CreditCards.com found that of people who carry a credit card balance, 22% did so because they believed it would help their credit score.
But carrying a balance on your credit card doesn't increase your score, it just means you'll pay more money over the long term as your interest payments build. With interest rates at record highs — currently 17.73% on average, according to CreditCards.com — it's a costly myth.
"The best way to use a credit card is to make charges during the month and then pay it off in full before the statement is due," says Rossman.
About four in 10 Americans don't know how their credit score is determined, according to a recent survey from CompareCards by LendingTree. But it's not that complicated.
How to build your credit score
Your FICO credit score, a reflection of your credit report, is what banks and other lenders use to determine how credit-worthy you are. If you have a high score, then you have access to better credit card, insurance and loan rates, as well as other perks, like potentially lower security deposits.
FICO scores range between 300 and 850, and a "good" score is considered anything above 700. An "excellent" rate of 750 or higher will secure you the best interest rates on loans, while falling below 650 could mean higher rates or reduced access to credit lines in general.
How your credit score is determined
Your score is determined by five factors, all of which are weighted differently. The most important factor is your payment history, which comprises 35% of your score. If you make on-time payments every month, your score will improve. If you don't, your score will drop.
Your credit utilization rate, or how much of your credit line you're using at any one time, is the second most important factor, accounting for 30% of your score. Experts advise keeping it below 30% to maximize your score. So, for example, if your credit limit is $2,000, you'll want to put no more than $600 on your card. The less you use, the better.
It's especially true in Pardoe's case, Rossman adds. The quickest ways for him to increase his credit score are to pay his bills on time and keep his balances low.
"That's the irony of carrying a balance to improve your score," says Rossman. "It won't work, and it's also raising your utilization rate. If you have the cash to pay it off there's an added benefit to that."
The length of your credit history, your mix of credit accounts and the last time you applied for new credit are also factored into your score.
"Your credit card only works for you if you're paying the bill in full and avoiding interest," says Rossman.
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The most important factor in determining your credit score is your payment history.
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