Do you pay your credit card bill in full each month or do you carry a balance? In other words, are you a transactor or a revolver?
Many people have experienced both sides of the coin. Take Jerry Koller, a real estate broker with International Home Realty in Irvine, California who lived the revolver lifestyle for years.
“When I was younger I used credit cards like a bank account,” says Koller. “Many times I did not have the money to pay them off so I would make minimum payments… I sat down one day and calculated the cost of using their money, and I almost fainted.”
Koller created a plan to pay off each credit card, starting with the account that had the highest interest rate. It took some time, and today he’s a transactor who uses one credit card, if he has the money to pay the bill in full, and a debit card. “I sleep at night,” says Koller.
According to the American Bankers Association’s November 2016 Credit Card Market Monitor report, 29.5 percent of credit cardholders are transactors, and 42.5 percent are revolvers. The remaining 28 percent are dormant and didn’t have any activity during the previous three months.
Where do you fall? And how might being a transactor or revolver impact other parts of your financial life?
Revolvers and Transactors Could Have a High Utilization Rate
Contrary to what some people believe, your credit score doesn’t depend on whether or not you revolve a balance. However, your utilization rate, the percentage of the available credit you’re using, is an important factor in determining a credit score. A lower utilization rate is often better, and you can have a high utilization rate even if you pay your bill in full.
Imagine your billing cycle goes from the first day of one month to the first day of the next month. The sum of your purchases plus any fees and revolved balance will be the amount you owe. You’ll receive a statement near the end of your billing cycle, and the bill’s due date is usually 21 to 30 days later.
The amount of money you owe according to your statement balance is what’s sent to the credit bureaus. Meaning, if your statement balance says $1,000, your credit report could show that you owed $1,000 that month. If your credit card has a $1,000 credit limit, you’ll have a 100 percent utilization rate (assuming you don’t have any other credit lines) even if you pay the bill in full.
As either a revolver or transactor, you can help lower your utilization rate by limiting your purchases throughout the month.
Revolvers who are working to pay off their credit cards should keep it up. Remember, revolving a balance doesn’t help your credit–it just costs you money.
Transactors who enjoy earning rewards and don’t like the idea of limiting their spending can make early payments to lower their utilization rate. You may not want to bring your balance to zero before the end of your billing cycle as that could make it look like you’re not using the card at all. Instead, bring the balance low (perhaps under 10 percent of the credit limit) and pay the remainder of the bill before the due date, so you don’t accrue interest.
Revolving a Balance Might Cost You More in Interest Than You Think
The 25 to 30 days between the end of your billing cycle and your payment due date is known as your grace period. If you pay your credit card bill in full during by the due date you won’t have to pay any interest. When you make a late payment or revolve a balance, all the interest that accrued during the previous billing cycle and grace period will get added to your next statement.
When you continue to revolve a balance (i.e. are a revolver), you won’t get a grace period. As a result, you’ll accrue daily interest on your balance and new purchases.
Savvy transactors can use grace periods to their benefit. Steve Silberberg, the owner of FitPacking, which offers backpacking trips geared to help people lose weight, uses the interest-free period to help his business’s cash flow. He has three cards, each with different due dates, and puts large purchases on the card with the latest due date to ensure he’ll have the money to make a full payment. “I purchase blocks of hotel rooms – often $2,000 at a time,” says Silberberg. “That’s typically when I delay payment by using a different card.”
One final note about grace periods, they might not apply to cash advances or credit card checks. Even if you paid your balance in full the previous month, these types of transactions could start accruing interest immediately. You may also have a different interest rate for purchases, cash advances, and convenience checks.
Transacting Could Lower Your Debt-to-Income Ratio
While many people fixate on credit scores before applying for a loan, a credit score isn’t the only factor that lenders consider. Many lenders look at a wide range of information, including your employment and housing history, your income, and your debt.
Your debt-to-income (DTI) ratio – your total pre-tax income divided by your outstanding debts – can be just as important as your credit. For example, regardless of your credit, in most circumstances to be eligible for a Qualified Mortgage your DTI must be no higher than 43 percent.
A low DTI could also help you secure more favorable terms on a new loan or line of credit. (You can use this calculator to determine your DTI.)
Transactors don’t add credit card debt to the equation, but revolvers do. If you’re planning on applying for a loan or line of credit soon, try to aggressively pay your existing debts down or off before submitting an application.
By now you can likely see that revolvers tend to get the short end of the stick. They can accrue interest daily and might have higher utilization rates and DTI ratios than transactors. These factors can put them at a disadvantage when applying for new credit accounts and result in thousands of dollars in extra interest charges in the long run. That’s not to say revolving doesn’t have its place.
During an emergency, carrying a balance on a credit card for several months may be a good alternative to other more expensive financing options, such as a payday loan. Even during non-emergency situations, making a large purchase and following through on your plan to pay off the credit card debt could be a wise decision. But generally, if you want to be in as strong of a financial situation as possible, aim to be a transactor.