Posted by William Charles on June 24, 2014
Credit Scores

Published on June 24th, 2014 | by William Charles

9

How Does A Charge Card Affect Your Credit?

Today’s question was originally asked by vtfan08  on reddit.com/r/churning. We have rephrased it slightly so it makes sense without the background discussion.

Question:

I’m tossing up between getting two cards, they both have the same benefits but one is a charge card and the other is a credit card.  I’m wondering how having a charge card will affect my credit? Which one will I be better off getting?

Answer:

It’s important to understand the difference between a credit & charge card.

  • Credit card: Has a preset spending limit and an interest rate. It’s possible to carry a balance on these cards and you’ll pay the interest rate as advertised.
  • Charge card: Has no preset spending limit (but purchases to the card can be denied or approved or a case by case basis) and must be paid in full every month. Because the card must be paid in full every month there is no interest rate associated with it.

In terms of affecting your credit the key difference is that one will change your overall credit utilization whilst the other will not. Your credit utilization is the amount of credit you’ve used, divided by total credit you have available. For example if you have one credit card with a credit limit of $1,000 and you’ve spent $100 on that card then you’re credit utilization will be 0.1 or 10%.

Anecdotal evidence suggests that for the majority of people their highest FICO score will be achieved when they have a credit utilization between 1 and 10%. The negative effects really seem to take hold when a consumer has a credit utilization above 30%, as this signals to lenders that they might be approaching a stage where they can no longer meet their credit obligations.

Charge cards are usually aimed at transactors (e.g people who spend a lot on their credit cards each month) as they are reliant on making their money on credit card processing fees, as well as any annual fees or misc fees. Credit cards are targeted at those who might carry a balance as they make the majority of their money from the interest charged on any balance.

Contents

Examples

Situation One

A person has a total available credit of $10,000, they have currently used $500 of that making their credit utilization ratio 0.05 or 5%. They plan to apply for a new card and put $8,000 worth of expenses on it each month, if they apply for a credit card this will have a limit of $10,000.

  • Option one, credit card: In this situation they total available credit would increase to $20,000 and their credit used would increase to $8,500. This would give them a credit utilization ratio 0.425 or 42.5% and their credit score would decrease.
  • Option two, charge card: In this situation their total available credit and credit used would stay the same, as would their credit utilization. In this case they would have the same credit score.

As you can see in this scenario you’d definitely be better off getting a charge card as you’re planning on using a large portion of the available credit on that card each month.

Situation Two

A person has a total available credit of $10,000 and they have used $5,000 of that making their credit utilization 0.50 or 50%. They plan to apply for a new card and put $500 worth of expenses on it each month, if they apply for a credit card this will have a limit of $10,000.

  • Option one, credit card: With this option the total available credit would increase to $20,000 and their credit used would increase to $5,500 causing their credit utilization to drop to 0.275 or 27.5%. As this is much lower than their utilization of 50% previously their credit score would increase.
  • Option two, charge card:  In this situation their total available credit and credit used would stay the same, as would their credit utilization. In this case they would have the same credit score.

As you can see in this situation you would be better off getting a credit card rather than a charge card as you’re only planning on using a small portion of the available credit each month.

Final Thoughts

In general the rule of thumb is as follows: If you plan on having a credit utilization which is lower than your current utilization on your new card you are better off with a credit card, otherwise you are better off with a charge card. In this specific case a lot of people recommend getting the charge card first, as you can then state that you want the flexibility of carrying a balance if you try to get the credit card later (to earn the sign up bonus). I don’t agree with this line of thinking, as it’s just as easy to say that you want the flexibility of no pre-set spending limit.

With credit cards it’s also important to remember that you can pay off the card before it reports to the credit bureaus in which case the credit utilization on that card would be 0%. The reporting date isn’t always the same as your statement cycle, you’ll need to either check your credit reports to see when each card issuer reports (it’s different for different cardholders). You can also try calling them to ask what date they report your balance to credit bureaus.

As always, we recommend never carrying a credit card balance. One of the great things about charge cards is that they don’t give you this option. 

 

 



9 Responses to How Does A Charge Card Affect Your Credit?

  1. Dirah says:

    Valid discussion.
    However, I don’t see how it pertains to the Chase Ink Plus and Bold.
    They are both business cards, and are not used to calculate your credit utilization.
    Unless something changed recently.

  2. Chuck says:

    “Option one, credit card: In this situation they total available credit would increase to $20,000 and their credit used would increase to $8,500. This would give them a credit utilization ratio 0.425 or 42.5% and their credit score would increase.” Should read “credit score will decrease”.

  3. Pingback: Credit Reports & Scoring Reference Pages - Doctor Of Credit

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