The way credit works can seem complicated. With multiple credit scoring models, three credit bureaus, and multiple factors influencing scoring and lending decisions, it’s no wonder the system is confusing to many.
It is also not surprising that there are many myths around credit. You may hear that it will hurt your account if you check it out. You may think that closing a credit card is good for your credit. You may believe that your work history or assets influence your grades.
One of the most popular myths suggests that having a balance on your credit card can help your credit score. It won’t. In fact, the habit of keeping a balance can even damage your credit score and your financial health. Read on to find out why and what to do if you need to carry the balance.
Is it better to pay off the credit card or carry the balance?
It’s always best to pay your bill in full by credit card. While it is important to use your card regularly to maintain your relationship with the issuer, you can do so without changing your balance.
A credit card balance will not help your bill. In fact, it can cost you credit points, not to mention the money that goes towards interest.
“It’s not clear where the myth that having a credit card balance helps your credit history comes from,” says Anna Barker, personal finance expert and founder of LogicalDollar. “However, neither FICO nor VantageScore awards additional points if you have a balance.”
How having a balance can hurt your credit history
Your FICO credit score is calculated based on the following five factors:
Of these, credit drawdown is a category in which having a balance can negatively impact your credit. Since this represents 30% of your credit score, the damage can be significant.
Your credit utilization ratio is your credit card balance compared to that card’s limit, expressed as a percentage. For example, if you have a $3,000 balance on a card with a $10,000 credit limit, the credit utilization rate for that card is 30% and you can lower it.
The general advice is to keep your credit utilization rate below 30%. Anything higher can negatively impact your credit score. If you can’t pay your credit card bills in full, you should still try to keep this ratio in single digits – the lower the better.
“Having a balance tells creditors that you are unable to pay off your debts,” explains Ty Stewart, CEO and President of Simple Life Insure. “Frankly, this suggests that you are not managing your money well, spending more than you earn. In the future, this will worsen your credit score and make it difficult to obtain soft loans in any form.”
How maintaining a balance can cost you money
Even if you maintain a low leverage ratio, maintaining a balance sheet is still expensive.
When you roll over your balance to the next billing cycle, you start accruing interest. Because credit card APRs are high compared to other types of loans, credit card debt accumulates quickly.
This is especially true if you have a secured card or another type of card meant for people who are building credit. Because consumers with lower credit scores can get approved for such cards, issuers mitigate credit risk by charging interest rates that are typically well over 20%.
What’s more, if you have a bonus credit card, interest can eat into your rewards. Even if you have a generous reward rate, it doesn’t match your credit card’s APR.
Consider the following scenario: You have a credit card with a fixed 2% cash-back rate and an annual interest rate of 18%. You take $1,000 and get $20 in cash, but you let that $1,000 roll over to the next month. Your account will be credited with approximately $15 in interest, bringing your rewards down to $5. If you continue to pay interest in subsequent months, your rewards may soon outweigh the interest payments.
For this reason, if your goal is to maximize your credit card remuneration, you need to pay off your credit card debt in full every month.
What if you need to carry the balance
While ideally you want to pay off every credit card bill in full, this may not be possible. There are good reasons why people prefer to have a balance and it doesn’t always have to do with not having enough cash. Maybe you’re working on building your emergency fund, or you’re financing a major purchase, or maybe you’ve had to cover an unexpected emergency expense.
If you find that you have revolving balances on your cards, try to get your credit usage down to 30% or lower to make sure your debt doesn’t hurt your credit.
To help you use credit, Barker recommends applying for a higher line of credit. If you can’t reduce your balance to zero, increasing your credit limit can be an easy way to lower your credit utilization rate.
“Sign up for balance alerts,” suggests Barker. “Most banks offer a service where they can send you a message or email with regular balance updates. Subscribing to them can be a good way to keep track of your credit card usage for a month so you can stop using the card if the balance gets too high.”
The next step is to reduce your credit card debt. A good way to do this is to create a budget and determine the maximum amount you can set aside for credit card payments. If the amount is too small, find out how you can earn extra money. For example, look for ways to increase your income or sell something from home.
“If you can find a way to make extra money this month, you should use it to pay off your credit card balance,” says Matt Woodley, founder of Credit Informative. “This will give you more wiggle room in an emergency and will also help you reduce the amount of credit you use. Once your credit card balance is paid off, you can use the money that went towards that payment to improve your financial future.”
It is also a good idea to look into credit card repayment strategies at this stage as well. You can try the avalanche method, where you pay off the credit cards with the highest APR first, or the snowball method, which suggests you pay off the cards with the lowest balance so you can see progress faster.
Whichever approach you choose, stick to eliminating credit card debt. The sooner you exit it, the less money you will lose on interest.
bottom line
Among the many credit myths, the positive impact of having a balance sheet is one of the most common. The truth is, it’s best to pay off your balances in full each month to protect your credit and your financial health. Even if that’s not possible, try to keep your balance as low as possible and look for ways to pay off your credit card debt. Your credit score will thank you, as will your wallet.
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The editorial content on this page is based solely on the objective judgment of our contributors and is not based on advertising. It was not provided or ordered by credit card issuers. However, we may receive compensation when you click on links to our partners’ products.
