You need a loan and you want the best interest rate possible. You know that a high credit score paves the way for the best interest rate offers – but did you know that your credit card balances contribute to one of the five factors used to calculate your credit score?
Your credit utilization, defined as the amount of credit you use compared to your credit limit, is one of the largest components of your credit score. When your credit balance is zeroed out, your credit utilization at that moment becomes zero as well. Creditors can see that you have managed your debts well and are capable of handling new debt.
Unfortunately, you probably aren't going to show a $0 balance even if you pay all your bills on time as soon as your billing statement is available. The amount reported to the credit reporting agencies is the balance on your billing statement on the reporting date – generally the end of the billing cycle. If that's the case, you won't have time for your payment to be posted before your balance is submitted to the credit reporting agencies.
The sure way to get a $0 balance on your credit report is to avoid credit for an entire billing cycle – pay off one billing cycle in full and don't charge anything for the next complete billing cycle. Your lender's reporting date becomes irrelevant.
You can also make payments before the end of the billing cycle to get a $0 balance. Most credit card companies allow you to check your balance online, so you know how much you have charged, including pending charges that have not been posted.
However, either of these strategies has a small flaw. Whether you pay off a balance early or simply avoid charging for a month, a $0 balance gives the appearance that you haven't used credit for an entire billing cycle.
If you post a $0 balance for just long enough to get your loan application approved, that can have a positive effect on your credit score – but, ironically, maintaining a long-term $0 balance (in other words, never using your credit cards) will reduce your credit score.
Length of credit history is the third most important factor in your score, including how long the account has been open and how long it's been since the account has been used. With no activity for a prolonged time, creditors can't assess whether you can handle credit responsibly under current conditions.
A short-term $0 balance, and therefore zero credit utilization, can raise your score – but don't obsess about getting exactly to zero. Focus on keeping your overall credit utilization at 10% or below to get the best results and stay below 30% at all times to avoid raising concerns with creditors. Try to place small charges on each account and make sure they are paid off in full every month.
While a low or $0 balance on your credit report can help your credit score and lead to better interest rate offers for your loan, it's not the only factor. Make all your payments on time, don't open other lines of credit while you're applying for the loan, and don't close or sideline older accounts in good standing.
If you've missed payments – or worse, suffered bankruptcy or defaults – the only cure is time. Take the other steps above, wait until a loan becomes absolutely necessary, and then shop around to get the best rate available at the time.
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