Rounding it up
Credit scores are an indicator of one’s creditworthiness, or how reliable you are with a loan.
Lenders use credit scores to identify not only creditworthy borrowers but also the ones that will generate the most profit.
A zero balance on credit card accounts does not hurt, but it certainly does not help increase a credit score either.
Ask first if you really need to borrow as lenders are out to make a profit on the funds they lend you.
Few numbers have a financial impact like the almighty credit score. Despite the importance of credit scores for securing mortgages or car loans, how rating agencies decide the rating for each person remains a mystery to most individuals. We’ll talk about how having credit cards with a zero balance impacts your credit score and the history and evolution of credit and credit scores. Knowing the strategy of credit agencies and the lenders they serve will help borrowers make solid financial decisions and avoid the pitfalls surrounding credit.
Lenders want to know both how reliable and profitable you are. If you have a zero balance on credit accounts, you show you have paid back your borrowed money. A zero balance won't harm or help your credit. To find out how we got here, we have to understand what credit is and the history of credit agencies. Let’s dig in.
5,000 Years of Credit
Borrowing has become a part of life in the modern world, so much so that it's easy to forget that credit isn't a natural concept for humans. It’s a relatively new concept for human cultures.
As civilization started to spread across the ancient world 5,000 years ago, so did the practice of debt and credit. People specialized as part of a civilization. One person might be a farmer, the other a weaver, each focused on their production. The problem became if a weaver needed wheat to eat, but the farmer did not need a shirt from the weaver. What were they supposed to do to make a fair trade?
No, they did not barter like many people falsely believe. Instead, they implemented a quick and easy solution. The farmer would give wheat to the weaver and say, “You owe me one.” The weaver understood that the farmer would ask him for a favour when he needed it.
“I owe you” is the basic foundation of credit. We all have said this phrase when borrowing or when we are in need now but don't have the funds or appropriate payment. What has changed since the farmer and weaver scenario is the addition of interest. When we borrow money from banks, the bank expects us to repay the amount owed plus extra to cover the expenses during the borrowing time. In short, the borrower must pay the lender for the time they borrowed money through interest.
This system works well until the borrower fails to pay back the loan. That is where the concept of creditworthiness and score comes in.
A Quick History of the Credit Score
What exactly is a credit score? The question is so simple that many refuse to ask about the importance of the three-digit score. In short, a credit score is a prediction issued by a credit agency on how likely a person is to repay a loan.
Agencies in the United States and Canada focused on the creditworthiness of various railroad companies that boomed during the westward expansion of both countries. The problem was that the British Empire and other parts of Europe had the most wealth. Scams from fake railroad companies abounded as North America spread further west, discovering more and more natural resources that could be shipped back east and across the Atlantic to Europe.
Consequently, businesses emerged that could provide investors with high-quality information on the legitimacy of these US companies. Many of these agencies are still recognizable 120 years later. Henry Poor’s publishing company, which focused on railroads and new canals, is an example. The Standard and Poors (S&P 500) Index in the United States Stock market still holds the name.
Some sharp business owners realized they could take the business credit rating system and apply it to individual people. One of the first firms was Dun and Bradstreet, whose agents gathered information on people looking to borrow from banks. Unfortunately, many of these firms often collected very personal information and were subject to controversy over much of the 20th century.
The Atlanta Retail Credit Company gathered files on millions of Americans, including social status and information about their sexual lives. According to a 1968 New York Times article, people lashed out against the rating agency when it digitized its records. After congressional hearings in the 1970s, the Retail Credit Company renamed itself Equifax, and three-credit numbers were created.
The goal of the credit agencies in Canada and the United States remains the same: to provide lenders with a prediction for how likely a person is to repay loans via a credit score. In addition, a credit score signals to the lender how profitable a borrower may be. While collecting private details is banned in Canada and the United States, credit agencies keep detailed records of how many credit accounts a person has and how well they repay their loans.
The Profit Motive
To understand credit scores, borrowers need to understand the motivation behind corporations issuing credit scores: profit.
Lenders want to know if borrowers will repay the original loan and how much profit they can make from the borrower. Interest rates are the way a lender makes a profit on a loan. The bank wants to avoid someone that will default on a loan because it becomes costly to collect the loan or negotiate with the borrower for lower payments. Sometimes, the process ends up in court. Again, this is costly for lenders, so they try to avoid those with a bad payment history.
With credit scores, lenders identify those borrowing large sums and making those payments without fail. Many people in the modern world treat debt so naturally that they don't mind paying fees and interest rates on borrowed money. These borrowers are a gold mine for lenders as they often charge big spenders high-interest rates plus additional fees, such as monthly membership charges or administration fees during the borrowing process. Canadian law regulates many interest rates and fees under fair lending practices, but fees and high-interest rates exist. Lenders can use credit scores to identify these profitable individuals and advertise to them directly.
Keeping A Zero Balance On Credit Cards
With the foundational knowledge of credit, credit scores, and what motivates lenders, we can finally address what happens when a borrower keeps a zero balance on credit cards.
For a credit agency to predict the borrower’s ability to repay in the future, it needs to see a history of how well the borrower repaid loans in the past.
If you have never borrowed before, how do you promise that you can repay in the future? It's not an easy chicken or egg problem to solve - credit companies are reluctant to lend to people with no borrowing history.
The solution for both borrowers and lenders is credit cards. Most credit card companies allow a borrower with no credit history to open an account. They limit how much you can borrow and charge a high-interest rate if you don't pay off the card monthly. Regardless, it’s a first, small, and positive step for most borrowers.
Some people realize they can open a credit account and assume that if they don't use it, they can build their credit score and history without the risk of having to pay interest or fees. However, credit score agencies are more clever than that. They want to see your borrowing habits and how much of a balance you keep, how much interest you can pay, and of course, if you fail to pay any bill.
Opening accounts with a credit card company won't hurt your credit score, but having zero balances does not allow you to prove to lenders that you're creditworthy and will repay a loan.
Lenders want to ensure you pay them - and with interest. That is why a credit score is often at its best when the borrower is paying both the principal and interest rates on a timely and regular basis. Zero balances on credit accounts are not harmful or helpful, as they won't help you, as a borrower, to prove you're creditworthy to lenders.
Is It Bad to Have a Zero Balance on Credit Cards?
To sum things up, the answer is no, it isn't bad to have a zero balance on your credit cards. In fact, having a zero balance or close-to-zero balance on your credit cards can be beneficial in many ways. A few of the most important benefits are: reducing debt, improving one's credit score and avoiding late payments and/or interest charges. Keeping a zero balance on your credit cards might also help you avoid overspending as well as make budgeting easier since all transactions will be visible at once.
What Happens If I Have Too Many Credit Cards with a Zero Balance?
Having more accounts open makes it easier to get a credit score, which improves your appearance to lenders. Credit agencies like to see that you have more than five credit accounts open at any time. However, multiple accounts may be difficult to track, resulting in missed payments that lower your credit score. You must decide what you can manage and what will make you appear most desirable.
Having too many cards with a zero balance will not improve your credit score. In fact, it can actually hurt it. Credit agencies look for diversity in accounts, such as a mix of revolving and installment loans, to assess risk. A lack of use on many cards signals that you are not actively managing your finances or taking advantage of any potential benefits from the cards.
Why Shouldn’t You Keep Your Credit Card Balance at Zero?
First of all, when you don’t owe any money on your credit cards each month it becomes difficult to establish good credit history. Without actively using and paying off your cards regularly, lenders won’t be able to assess whether or not you would be a responsible borrower. This can make it difficult to secure loans or other credit in the future.
Additionally, when you don’t owe anything on your cards each month, you won’t be building up any rewards points or cashback for purchases made with those cards. Most issuers provide one-time bonuses and ongoing incentives for cardholders who use their cards frequently and pay off any balances at the end of the billing cycle. These rewards can be used to offset expenses like travel costs, groceries, and more.
Finally, having no balance on your credit cards can also mean that you are missing out on taking advantage of 0% interest rate promotions. Many card issuers offer promotional periods that can help you to save money on purchases made during these times. If you don’t have any balance on your cards, you won’t be able to take advantage of any offers from the issuer.
While having a zero balance on your credit cards may seem like a desirable goal, it is important to consider the potential drawbacks before making this decision. Building up credit history and taking advantage of rewards programs are important considerations when determining how best to use your cards each month.
A Note on Negative Balances
You can also have negative balances on your credit card. A negative balance indicates that you have received a cash-back incentive from your credit card company, overpaid your bill, or returned something purchased with a credit card. Negative credit is better than a prolonged zero-dollar balance, but you should spend money to take advantage of your savings.
Ask Yourself If You Need To Borrow In The First Place
The best tip is to ask yourself if you need to borrow in the first place. The best way to build financial health is to avoid taking on debt. Lenders are looking to make a profit from you as a borrower. Nothing is wrong with this, but it's important to realize that paying interest adds up quickly over the years. Money paid in interest is money that cannot be used for savings.
Borrowing is useful at certain times in life and is a perfectly usable option, but it often becomes a crutch and leads borrowers down an increasingly dangerous circle of debt, interest payments, lack of savings, and adding more debt.
Jordan T. Hedberg
Jordan is a former Broker and current community newspaper Publisher. When he is not researching and exploring the financial world he can be found raising grass-fed beef and goats in the Colorado Wilderness.