One of the biggest credit score myths is that having an excellent credit score requires going into debt. For example, Dave Ramsey’s website says that “The only way to have a good credit score is to go into debt, stay in debt, and continually pay your accounts perfectly—without adding too much debt or paying too much off. In other words, stay in debt for as long as you can.” That advice makes it sound like you have to borrow money and pay interest in order to have a good credit score, and that is simply not true.
In this post, I will try to clarify the myth and explain a simple strategy to ensure you have a great score and avoid expensive debt completely. To understand where this myth comes from, you have to understand the concept of a statement balance.
What Is A Statement Balance?
If you use a credit card during the month, you will receive a statement at the end of every billing cycle. That balance is your statement balance, and it will be reported to the credit bureau. If you pay that statement balance in full, the vast majority of credit cards do not charge you any interest, because you are taking advantage of the grace period.
Technically, you have a debt with your credit card company. But, because you pay your statement balance in full every month, that debt costs you nothing. And it is very similar to your cell phone bill. As you use your phone during the month, your statement balance accrues. You owe your phone company money. But, so long as you pay the bill on time, you are not going to end up paying any punitive charges for the bill.
How To Build An Excellent Credit Score
Your FICO credit score is built using the following variables:
- 35%: Do you pay your bills on time?
- 30%: How much debt do you have? And what is your utilization?
- 15%: How long have you had credit?
- 10%: How many different types of credit do you have?
- 10%: Have you applied for a lot of new credit recently?
Here is a simple way to get an excellent credit score. Imagine you have a single credit card with a limit of $5,000. You set up automatic, recurring monthly payments for your cell phone bill using your credit card. And then you set up automatic, monthly payments from your checking account to your credit card. So your monthly statement balance would be $80, on a limit of $5,000.
Every month, your phone company will automatically charge your credit card for your monthly bill. And then every month your credit card company will automatically debit your checking account for the payment. Doing this will build an excellent score for the following reasons:
- You are paying your monthly bill on time. And, by automating the payment, you know it will happen every month.
- Your total “debt” will be very low. You are only using $80 of your $5,000 available credit. And it will not cost you anything. You are not drowning in debt by using this strategy.
- By repeating this over time, your score will improve over time.
My wife moved to the United States from Europe and had to build her credit score from scratch. By using this strategy, her score was above 700 within 18 months.