Why You Can Pay Your Bill in Full Every Month and Still DamageYourCredit
This guest article was provided by Odysseas Papadimitriou, the Founder of CardHub.com—a website that helps people get the best credit card deals.
Do you pay your credit card bill in full each and every month? Maybe you do, maybe you don’t, but no matter what, you’re probably aware that it’s best for your financial health to do so. Such credit card use exhibits consumer responsibility and can save you a ton in interest. Again, you probably know all this. What you might not be aware of is the importance of credit utilization in the minds of the credit scoring powers that be or the fact that paying your bill in full might not be enough to garner a high credit score, particularly if you use a No Preset Spending Limit (NPSL) credit card or charge card.
You most likely aren’t even sure exactly what credit utilization is. Credit utilization is a ratio of the credit you use as compared to the credit available to you. Credit utilization ratios are calculated individually for each of your credit cards as well as for all of them collectively and included in your FICO score, the most widely-used credit score. It’s therefore important to limit your monthly spending to around 40% of your available credit, unless your credit line is relatively small. For example, there’s not much of a difference between spending $80 and $180 when your credit limit is $200, but there’s a significant difference between spending $4,000 and $9,000 when your limit is $10,000.
But what happens if your credit card doesn’t have a credit limit, or at least you think it doesn’t? What happens when your credit card company won’t tell you your credit limit? How can you maintain low credit utilization then? Better yet, how can credit scoring agencies even calculate credit utilization without credit limits?
Therein lies the problem with No Preset Spending Limit credit cards and charge cards. Whether you think these cards don’t have spending limits—as many people do—or you know that their limits are simply determined on a month-to-month basis and not conveyed to consumers or the major credit bureaus, it’s obvious that they throw a wrench into the credit scoring process. However, the way in which they do so is perhaps worse than you might imagine. According to our NPSL Card Study, issuers either don’t report limits to the credit bureaus for their NPSL cards or they report various arbitrary proxy limits.
At this point you might be asking yourself, ‘Since NPSL cards do have actual spending limits, why don’t issuers just report them?’ Great question. Ostensibly, the reason issuers don’t report NPSL cards’ actual limits is because they are variable, changing based on your spending and payment history as well as trends in the economy. However, the main reason issuers are so secretive about NPSL card limits is that they want to propagate the myth that NPSL cards have no limits. It’s what makes them money; it’s what helped Visa Signature credit cards, World MasterCard credit cards, and the charge cards from American Express and Chase become some of the most popular financial products for people with excellent credit.
Unfortunately, when credit limit information is conveyed misleadingly to the credit bureaus, it can lead to misleading credit utilization ratios, which in turn might lead to a misleading credit score. To further complicate matter, the extent of any potential credit damage is often difficult to predict because it depends on both the breadth of your credit history and the exact way issuers report their NPSL cards’ limits, which varies.
NPSL cards therefore make it difficult to maximize your credit score and might actually end up causing damage. Given that they don’t bring any unique benefits, their use should be avoided. Luckily there are a plethora of excellent options, like rewards credit cards, that can serve as replacements. So compare all of the non-NPSL choices available to you and get a credit card for excellent credit that will allow you to maintain low credit utilization and a high credit score.