Actual FICO Scoring Factors that Bust this Myth

Let’s get this out of the way right now. It is a myth that you need to carry a balance on your credit card to build your credit. You don’t need to be in debt to have a good credit rating. In fact, carrying a balance on your credit cards naturally puts you at a higher risk of missing a future debt payment. This prediction is, after all, the purpose of credit scores. I don’t know where this myth started, how long ago, or who started it, but we might have an idea of how the myth may have begun. Myths often come about as attempts to explain the seemingly inexplicable, but they also involve misunderstandings and misinterpretations of reality. This is definitely the case here with this one.

Does carrying a balance on your credit card help your credit rating?

Carrying a credit card balance triggers eleven negative scoring factors that affect your credit score. Three factors mention problems with accounts that have no balance, but these three codes actually refer to accounts with no activity rather than no balance.

The FICO Scoring Model We Are Using for Official Reasons

The factors identified below (also known as “reason codes”) come from FICO’s NexGen credit scoring model from the mid-2000s to the early 2010s. FICO.com published the codes back in 2013 in a rare instance of openness and transparency within an industry full of trade secrets and proprietary formulas. While FICO has since replaced its NexGen scores with the FICO 8, 9, and 10 models, you can reasonably assume the newer scoring models maintain many of the same codes. Moreover, FICO’s main competitor, VantageScore, has even published a website at ReasonCode.org that explains its own codes. In many cases, the codes are identical to those used by FICO.

Even as FICO and VantageScore inevitably release new scoring models in the future, the reason codes explained below will also support informed decision-making because they have been proven to accurately predict the consumer’s future credit-related behaviors.

3 Confusing Credit Card Balance-related Credit Scoring Factors 

It would be easy to assume, because they all contain the phrase, “no recent balance,” that these three FICO reason codes penalize consumers who do not carry debt on their credit cards. However, further scrutiny reveals that the scoring model penalizes consumers who do not use their credit cards, not those who do not carry balances on them.

ReasonCode.org lists two reasons with a single code similar to the three FICO reasons: “09: No open accounts with a balance” and “09: You have no open accounts with a balance.” Its explanation of the code clarifies that the scoring model (logically both the VantageScore and the FICO score) cannot generate its predictive score if the consumer does not have an open and active account on her or his credit report. It says nothing about actually carrying a balance from one month to the next.

FICO Reason Code G3: No recent bank/national revolving balances 

Bank and national revolving accounts include the most well-known types of credit cards. National banks include Citi, Chase, Bank of America, Capital One, American Express, Discover, and probably Wells Fargo, to name a few.

If you have no such credit cards, then the FICO scoring model will have a more difficult time predicting your future credit-related behavior. However, even if you have one or more credit cards from these financial institutions, FICO can’t use them to predict your future behavior if you aren’t using them regularly. No purchases and payments mean no useful data.

FICO Reason Code G5: No recent retail balances 

Retail accounts refer to store credit cards. These tend to offer credit with lower standards for qualification, but they can still build (or destroy) your credit rating, depending on how you use them. A few common retail credit cards include Kohl’s, Target, JC Penney, TJ Maxx, Old Navy, and Fingerhut.

If you have no retail card accounts, FICO cannot use the additional information as a factor in your credit rating. If you are making regular purchases, how and when you pay them can become predictors of future behavior on other credit accounts.

FICO Reason Code G6: No recent revolving balances 

This code looks very similar to the G3 and G5. However, it allows for a more general description of revolving accounts (i.e. credit cards). Its existence insinuates that having only retail or national bank credit cards might hurt your credit rating. Given the lower qualification standards of retail cards, we can presume that having only retail credit cards and no national bank cards will not have the same level of positive influence on your credit rating. To maximize your credit-building activities, you should have an active bank credit card and an active retail card.

Credit Card Balance-related Factors that Hurt Your Credit Score 

The rest of the FICO reason codes citing the consumer’s balance all have to do with the consumer carrying too much debt on one or more debt products. Of the 132 NexGen FICO reason codes, 25 have to do with account balances. The following 11 of those 25 codes attempt to identify consumers who are overextended when it comes to credit or are otherwise at high risk for missing future payments due to their recent or current balances.

FICO Reason Code M6: The Number of bank/national revolving accounts with balances 

Carrying a balance on multiple credit cards from national or even regional and local banks will hurt your credit score thanks (or no thanks) to this code. The more bank-issued credit cards you have with balances on them, the more this code will drag down your credit rating.

FICO Reason Code N6: The Number of retail accounts with balances 

Unlike reason code M6 above, N6 refers specifically to cards issued by retailers. Examples might include Kohl’s, JC Penney, Macy’s, or even gas cards. This is just one reason why we recommend you pay off your card balance before you ever leave the store.

Go ahead and make a purchase on the card, and get the 10% or 15% discount, but don’t leave the store without first visiting the customer service desk. There, you can pay off the account in full so you never have to worry about carrying a balance or paying the high-interest rates associated with these cards.

FICO Reason Code P3: The Proportion of balance to limit on retail accounts is too high 

While the N6 code refers to how many retail cards you have with balances, this P3 code has to do with the size of those balances. The closer your balances are to your credit limits, the more it will hurt. If your balance exceeds your credit limit, it will hurt even more.

The more you pay down your balances, the less likely you are to miss payments in the future and, consequently, the higher the credit rating you will have.

FICO Reason Code P5: The Proportion of balances to credit limits on the bank/national revolving or other  revolving accounts is too high 

Code P5 is similar to P3 except that it refers to any balances you carry on a credit card, whether issued by a national, regional, or local bank, by a credit union, or by other creditors. Whether you have a Capital One or a Capital City bank MasterCard, a Visa from Chase or a credit union in Chevy Chase MD, a Bank of America or a card from Bank of American Fork UT, a Citi card or a River City KY bank card, you should keep your balances at $0 or as far away from its credit limit as you can afford.

FICO Reason Code P6: The proportion of balances to credit limits on revolving accounts is too high 

This code may seem like a duplicate of Code P5. This is understandable when you have more than 130 total reason codes working together. However, P6 refers to how close your balances are to your credit limits on ALL your revolving accounts, not just your bank card balances. All your revolving accounts would include credit cards from major banks, credit unions, local and regional banks, as well as retail stores.

Basically, this code disqualifies the belief that you can spread out your balances across all your accounts without hurting your score. The P6 code looks at your entire revolving credit usage, not just how you are using one or two accounts.

FICO Reason Code PA: The Proportion of balance to limit on retail accounts 

Reason code PA is an exact duplicate of reason code P3, except it’s missing the phrase, “is too high.” In full honesty, we are not going to speculate how these two payment codes differ from each other. What we can say for certain is this: the higher your balance on retail accounts (whether a single account is maxed out or you have tried to spread out your balances across multiple retail accounts), the more it will hurt your credit rating.

FICO Reason Code Q0: The proportion of revolving balances to total balances is too high 

Reason code Q0 gives a bird’s-eye view of your revolving account balances. It takes into account card balances from all sources (retail stores, banks, credit unions, etc.) and compares them to your total balances. While not fully clear, the term, “total balances” appears to lack reference to revolving account balances. As a result, this code seems to indicate that carrying credit card balances that approach your total debt balances can hurt your score.

This means that having ONLY credit card balances without any installment loans, mortgage debt, or other debts will push down your FICO credit score. Why? Statistics must show that consumers who only have credit card debts (no mortgage, student loan, auto loan, etc.) are at higher risk of missing payments than those with a variety of debt types.

This is certainly not to say you should rush out and get a bunch of different types of loans. Instead, if all you have are credit cards, keep your balances at $0 or pay down your balances as quickly as possible.

FICO Reason Code Q1: The Proportion of balances to credit limits on the bank/national revolving accounts is too high 

Reason code Q1 looks similar to P5 above except that it only involves credit cards issued by national financial institutions and banks. So, carrying a high or maxed-out balance on a credit card from a major bank will hurt your credit score as a result of this factor.

FICO Reason Code U8: Too many recently opened retail accounts with balances 

The U8 reason code will lower your credit score if you carry balances from month to month on multiple retail card accounts, regardless of the size of those balances.

So, next time you think you can’t pass up the back-to-school sales at Macy’s and Kohls, and Old Navy, keep in mind that your credit will suffer if you use their in-store cards and don’t pay off the balances immediately. Plus, it helps to remember that sales are not opportunities to save money but occasions to spend. Nobody comes home from a sale with a larger savings balance than before as a result of spending money.

FICO Reason Code V0: Too many recently opened revolving accounts with balances 

With this reason code, FICO reinforces the idea that activity on newer accounts is a better predictor of future behavior than activity on older accounts. If you are new to credit building or have newer credit cards and store cards that you start carrying a balance on, you are statistically more likely to miss payments in the future than someone who carries a balance on an older account.

FICO Reason Code V4: Too many recently opened bank/national revolving accounts with balances 

Like reason code V0, V4 will penalize the cardholder if she or he carries a balance (whether small or large) on one or more new accounts. This one, though, specifically refers to bank and national credit cards, excluding retail store card accounts.

Definitive Reasons to Build Your Credit Without Carrying a Balance 

Given the overwhelming number of factors that penalize cardholders for carrying balances on their credit and store cards, no one should argue that it’s good for your credit rating to carry a credit or store card balance. Obviously, large balances on your credit cards that make them appear to be maxed out will hurt. But even small balances on recently opened cards will hurt. Additionally, small balances on multiple banks and retail cards can drag down your credit rating.

Best Advice: Use reasonable and simple steps to build or rebuild your credit rating rather than trying to play the balance game. See our recommendations here.

When it comes to your balances, use your credit and store cards only to buy what you would be able to afford in cash anyway. Then, pay them off immediately (before leaving the store or scheduling a payment the same day).