We all make decisions based on how we can improve our credit. One such decision is whether or not to carry a small balance on your credit card.
Many people believe that carrying a small balance on your credit card will help improve the credit utilization portion of your credit score. Others pay off their balance each month to avoid interest payments. But which way will help you most in the long run?
If you are interested in learning about the effect of your credit card balance on your credit score, check out our in-depth article below.
Credit Utilization and Credit Card Balances
The main reason that people choose to carry a balance is that they believe it improves the credit utilization portion of their credit score. Credit utilization makes up about one-third of your overall FICO score calculation, which is why many people are driven to improve this portion of their score.
However, many people don’t understand how credit utilization is determined and make decisions based on the misguided belief that it will improve their score. Your credit utilization or balance-to-limit ratio on your credit card is not determined by what is leftover on your credit card balance. It is determined by the amount of your line of credit you use in a month.
Think of it this way: your credit utilization refers to the amount of your credit limit that you take advantage of each month. Experts say that you should keep your credit card utilization at about 30%, meaning that you only use 30% or less of your allotted credit limit.
When you spend on your card, you are still utilizing that line of credit. Paying off your entire balance doesn’t diminish this and actually saves you money on interest payments.
Should I Leave a Balance on My Card?
The myth that carrying a balance on your credit card will help your credit score is not true. The only thing it will accomplish is costing you more in interest.
Some people reason that leaving a balance on their card helps improve their credit utilization score, but not paying your entire balance can actually hurt your score. Credit scores are designed to give lenders an indication of what kind of borrower you are. In essence, they speak to your ability to pay your debts on time and in full.
The single worst thing that you can do for your credit score is make late or incomplete payments. Credit experts say that this will tank your score more than anything else. If you are leaving a balance under the belief that it is helping your credit score, ditch the practice in favor of paying off your credit card each month.
Why You Should Pay Off Your Credit Card Each Month
When you pay off your balance on time, you can avoid interest being charged on those purchases. The best time to pay off your balance is before or on the due date, after which the issuer may report your balance to credit agencies. If this happens, you could see a dip in your credit score due to nonpayment.
In addition to avoiding interest payments, paying off your credit card balance each month gives you access to a grace period. A grace period refers to the time it takes for an issuer to charge interest on a credit card purchase. This usually starts on the last day of the billing cycle and ends when payment is due.
So, should you pay off your balance after every transaction? While this may ease some anxiety about building up too much of a balance, paying off your card after every transaction is effectively not using any credit at all. You want to use between 10% and 30% of your available credit to build your credit score. It shows credit bureaus that you are capable of responsibly using a line of credit.
Will You Pay Your Credit Card Balance Each Month?
Carrying a balance to increase your credit utilization score is a myth. The best way to build your credit score is to use 10% to 30% of your credit card limit and pay off the balance in full each month.
If it is difficult for you to keep your purchases under 30%, work on coming up with a budget. Many people find it helpful to use their credit card for only essentials like groceries and gas and pay for extras in cash.
Credit cards help teach responsibility around a line of credit. They can help you build your credit score so that you can make larger financial decisions in the future. The key when it comes to credit cards is to keep interest payments to a minimum and only use credit as you need it.
For more tips on credit card best practices, be sure to check out some of our other articles here.