Improve Your Credit Score

Aver­age Daily Bal­ance

There’s a good chance you’ve never heard the term “Aver­age Daily Bal­ance” (ABD), but it affects over 75% of Amer­i­can adults. And that’s because over 75% of Amer­i­can adults have at least one cred­it card.

In essence, ABD is a for­mu­la that deter­mines how much inter­est you’ll pay at the end of your cred­it card billing cycle. If you think the inter­est charge is cal­cu­lat­ed by mul­ti­ply­ing your APR by the bal­ance on your card at the end of the month, you are wrong.

It’s actu­al­ly cal­cu­lat­ed by mul­ti­ply­ing your APR by—you guessed it—your aver­age daily
bal­ance. That means you could be pay­ing much more inter­est than you need to! Let’s use an exam­ple to illus­trate why: imag­ine you receive two pay­checks each month—one in the mid­dle and one at the end. Since you don’t know about ADB, you wait until the end of the month to make your cred­it card pay­ment. That means the aver­age bal­ance on your card through­out the month is as high as possible…leading to high­er inter­est charges.

What if you instead split your cred­it card pay­ment into two – one in the mid­dle of the month and one at the end? If you start­ed the month with a bal­ance of $4,000 and made a pay­ment mid-month of $3,000, your aver­age daily bal­ance for the month would be $2,500—which is $1,500 lower than what it would have been if you wait­ed until the end of the month to pay. Assum­ing your APR on the card is 20%, you would save your­self about $3,000 worth of unnec­es­sary inter­est charges per year!

Cred­it Uti­liza­tion

Believe it or not, you can be penal­ized for using all the cred­it that has been offered to you. That’s because one of the main vari­ables in deter­min­ing your cred­it score is how much of your avail­able cred­it you’re using. The term “cred­it uti­liza­tion” refers to the ratio of your total debt to your remain­ing avail­able cred­it. For exam­ple, if you own a cred­it card with a cred­it limit of $20,000 and then you put enough pur­chas­es on it to reach the limit, your cred­it uti­liza­tion would be 100%. As you can prob­a­bly guess, that’s not good for your cred­it score. Fur­ther, if you also had an auto loan for $20,000 that was half paid off, then your total cred­it uti­liza­tion would be 75%. Experts usu­al­ly rec­om­mend a cred­it uti­liza­tion of no more than 30%, but it depends on your indi­vid­ual sit­u­a­tion.

Under­stand­ing this con­cept can help you save money through­out your life. Many peo­ple close a cred­it card once it has a zero bal­ance, but if you’re informed about cred­it uti­liza­tion you will often real­ize it makes sense to leave the card open (as long as it won’t tempt you to get in debt). As long as it remains open, the avail­able cred­it on the card will help your cred­it uti­liza­tion—and boost your cred­it score.

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