Using a credit card to buy lunch or a cup of coffee may not feel like a loan, but it can be if you use it as revolving credit.
Revolving credit is a credit line to borrow against and repay repeatedly. The amount of credit you can use each month is your credit line, or credit limit, and can be used as little or as much as you want up to that amount.
If you pay off the balance when you get your credit card bill at the end of each statement period, you don’t have to pay interest. Revolving credit, however, is when you don’t pay it off in full each month and carry some part of the balance, or revolve it, over to the next month and pay interest.
This can make a $3 cup of coffee and a $20 lunch double in price over time.
As a revolving balance is paid off, more of your credit line becomes available to spend again. Not paying it off and keeping too high of a balance on a credit card can lower a credit score, with a user’s credit utilization ratio making up 30 percent of a FICO credit score.
Credit utilization is a way of measuring how much credit you’re using. To find yours, divide your total outstanding balances by the total amount of credit extended to you. For example, if you have $1,000 in revolving credit owed and have a total credit limit of $3,000, that equates to a credit utilization ratio of 33 percent. For the best credit score, experts and even the credit bureaus recommend keeping it below 30 percent.
To lower that ratio that the credit bureaus see, it can help to avoid running up a large balance on your credit cards and to pay the balance a week or so before you get the bill. The balance is often reported to the credit bureaus the day your statement closes, which is a few weeks before your due date, so paying it off early can lower the amounts owed on your credit score.
Revolving credit can be a good way to manage expenses. To use it effectively and improve your credit score, don’t carry a revolving balance by paying your credit card bill in full and on time each month. This should only improve your credit score, allowing you to possibly get the best credit terms on future loans.
This article is intended for informational purposes only and should not be construed as professional advice.