Use your credit card like a debit card
Read Time: 8 Minutes
I have never paid 1 cent in credit card interest in my life, and I plan to keep it that way. Meanwhile I have earned thousands of dollars in free travel perks and cash back. I’ve also earned a 765 FICO® Score, which can save me thousands more by qualifying me for low interest rates when Sophie (my wife) and I eventually buy a home.
How did I do all this? Simple. I learned how credit card payments and credit scores work, and then started using my credit card like a debit card. Let’s dive into how this strategy could save you money and boost your credit score.
How do Billing Cycles Work?
Many people have never actually looked at their credit card statements, so let’s start with the basics. Each of these dates should be listed on your monthly statement.
– Billing Cycle: This is the period of time, usually 1 month long, between credit card billings. For example, if you open your card on September 15th, your billing cycle will go from September 15th – October 14th, then start over again from October 15th – November 14th, and so on.
Note that your billing cycle depends on the specific date you opened the credit card. Thus, they are usually different for each credit card you own.
– Payment Due Date: This is the date by which you must pay off your statement balance to avoid owing interest. It is usually 20-30 days after the end of your billing cycle (for my Chase cards they give me 27 days). So if my billing cycle end on October 14th, I have until November 11th, 27 days later, to pay off my statement balance. After that, interest will begin to accrue.
Confused? See the hypothetical timeline below.
As you can see, credit cards allow you considerable time between purchasing the item at the store, and actually having to pay for it. If you bought an item on the last day of your billing cycle, you’d still have about 27 days before your payment date. And if you bought an item on the 1st day of your billing cycle, you’d have a whopping 57 days before your payment date!
That flexibility is one of most attractive features of credit cards. So why would I pay my credit card off sooner than I need to? And why do I usually make 2-4 payments per month? Let’s dive into the top 2 reasons.
1. It Controls My Spending
I realized a long time ago that when I waited too long to pay my credit card off, I spent money I didn’t have. This was because even though I had bought something, my bank account didn’t reflect that purchase until weeks later, when I paid my credit card bill.
This gave me the feeling, artificially of course, that I had more money than I really did. To be clear, I was still paying my full balance off, and paying it before my payment date so as to avoid owing interest. But that 57 day window was too long for my brain to mentally budget for.
Compare this to how a debit card works. Your debit card is linked to your checking account, and if you don’t have the cash available at that very moment, your card will get declined. I think it’s pretty obvious which payment method, credit or debit, encourages better spending habits.
What has worked much better for me is paying my credit card balance off each time I get paid, which is 2x per month. That way my inflows (my paycheck) and my outflows (paying my credit card bill) are more in sync. This strategy made it much easier to mentally budget my expenses and make sure I was living within my means.
And if I have a particularly large purchase, like a new TV or a plane ticket, I might make an extra payment just to make sure my checking account reflects that outflow. That’s why sometimes I’ll end up making 3-4 credit card payments per month.
It was only after I had been doing this for a while that I realized I was essentially treating my credit card like a debit card. But unlike debits cards, which offer no rewards, I was earning travel miles and cash back. How great is that?!
2. It Boosts Your Credit Score
The 2nd reason I pay my credit card bill off so frequently is because it helps boost my credit score. That’s one of the ways, even though I’m only 26 years old, I already have a FICO® score of 765.
This helps your credit score so much because “Amounts Owed” is actually the 2nd largest factor of your FICO® Score. 2nd only to your payment history. But don’t take my word for it. See for yourself from FICO’s own website.
That’s right, the amount you owe, also called your “credit utilization ratio,” makes up a whopping 30% of your FICO® Score. So how is your credit utilization ratio calculated?
Your credit utilization ratio is calculated by dividing your credit card balance by your overall credit limit. For example, if you owe $500 on your credit card, and your overall credit limit is $5,000, then your credit utilization ratio is 10% ($500 / $5,000 = 10%).
In general, the lower your utilization ratio, the better. You should aim to keep your utilization below 30% at the most. Below 10% is even better. In an interview with NerdWallet, Can Arkali, senior scientist for analytics and scores development at FICO, says that “Consumers with FICO scores of 800 use, on average, 7% of their available credit.” The graphic below, from Credit Karma, has a nice chart that shows how good/bad your utilization ratio is.
Here’s the trick though! Your credit card company usually only reports your balance 1 time per month, and that amount is usually (but not always) your end-of-statement balance.
So let’s say you spent $1,000 last month on your credit card, and your credit limit is $3,000. Your credit card company will likely report that $1,000 balance to the credit bureau, and your credit utilization will be 33% ($1,000 / $3,000 = 33%). That’s slightly above the recommended max of 30%.
Instead, let’s say you still spend the same $1,000, and your credit limit is still the same $3,000. But this time, you pay ½ off your balance off mid-month when your paycheck comes in, just like I do. Now, the balance that gets reported at the end of your billing cycle is only $500, because you already paid the offer ½ off. Magically, your credit utilization dropped from 33% down to 17% ($500 / $3,000 = 17%), even though you still spent the same amount of money!
Wrapping It All Up
Credit cards can be an amazing tool that can score you tons of perks, cash back and free travel. But they can also encourage you to spend more money than you should. For me, paying my credit card off 2-4 times per month helps me control my spending. It also helps my credit score by making sure my credit utilization stays low. This little hack of treating my credit card more like a debit card has helped me, and hopefully it can help some of you.
Let me know some of your spending/credit card hacks below in the comments.
The conclusions drawn throughout this website are not advice meeting the particular investment needs of any investor, and they are not intended to serve as the basis for financial planning, tax, or investment decisions. This website is for informational purposes only and is not a solicitation or an offer to buy any product, service, security or instrument. The opinions expressed throughout this website are my own and not those of any company I work for.