There are all kinds of myths surrounding credit cards, credit history, credit bureaus like Experian, and credit scoring. These personal finance ideas should not be taken as fact without first verifying their truthfulness through research and advice. Otherwise, you can hurt your credit. Unfortunately, once that happens, it can take a while before the negative effect your credit score will feel can be improved.
One example of a common myth is that it’s good for your credit score to leave a small balance on your credit card. Is this really a good piece of advice, though? It’s doubtful…
If you find yourself wondering, should I leave a small balance on my credit card? You’ve come to the right place. Let’s address this myth head-on by talking about what happens if you carry a credit card balance and why it may be more ideal to pay off your credit card every month instead.
Why Would You Leave a Credit Card Balance?
So where does this idea that you should carry a small balance come from? It stems from misconceptions that it will help you improve your credit score. Let’s take a closer look at a few reasons why some believe you should leave a balance on your credit card.
Demonstrate you can use Credit Responsibly
Your credit report contains a lot of information about your history including if you’re making on-time payments. There are three major credit bureaus that oversee your credit report: Experian, TransUnion, and Equifax.
Your credit card issuer will send information to Experian and the other bureaus on a monthly basis. Each item may factor into your credit score to either negatively or positively affect it. Lenders use this information to determine whether to offer their products and services (i.e. mortgage loan) to you.
Your credit card accounts must be active to consistently show lenders that you’re capable of repaying your debt.
Carrying a balance each month is certainly one way to do this. A better way to address this is to make regular purchases using a credit card each month.
Then be sure to make your payment by the due date each month. On-time payments make up 35 percent of your FICO score; the highest ratio among all the factors that affect your scoring.
Another major factor in credit scores like the FICO score is your credit utilization. This is the available credit versus the overall credit you have.
For example, if you are using $3,000 per month on your credit card and have a credit limit of $10,000, your utilization rate is 30 percent.
If you search on any personal finance website, you’ll find that recommendation is to keep your utilization rate under 30 percent. So in retrospect, if you have a credit card balance below this percentage, it shouldn’t hurt your credit.
However, if you’re not paying in full each month, it could make it harder to keep your credit utilization below 30 percent. When using your credit cards each month for your everyday purchases, you could push against your credit limit without realizing it.
It’s not worth risking the possibility to hurt your credit score by carrying a balance, no matter how small it might be.
The Downside to Leaving a Small Balance on Your Credit Card
Carrying a credit card balance to demonstrate a credit history on your credit report and help improve your credit score isn’t worth it. There are better ways to go about this without putting your finances at risk and costing you money. So, what exactly are the negatives to leaving a small balance on your credit card? Let’s discuss a few key points below.
It Can Get Costly
But carrying a balance on your account isn’t the best financial move to make to show you have an active credit card. Balances that are carried over each month are subject to interest.
Most credit card issuers charge double-digit interest on balances which can really add up. Interest is one of the key ways that issuers make money on credit cards. This interest will cost more money than it’s worth if you simply pay your balance in full instead.
Another financial mistake of using this tactic is that balance will add to your debt.
If you have an unexpected emergency such as losing your job, having a higher credit card balance is not ideal. You could be forced to carrying a higher balance if you’re needing to spend money in other areas of your personal life.
Or it could cause you to rely on your credit cards, eating up the available credit and putting you closer to your credit limit. This scenario is more avoidable when paying your card in full each month instead.
You Don’t Get Credit for It
Having a balance on your credit card every month isn’t something you really get any credit for on your credit report or credit score. In fact, you could end up negatively impacting your credit score if you end up in a situation where you can’t pay down your card to keep under the 30 percent.
Your payment history of paying by the due date will earn you more brownie points with the credit bureaus and your credit scores. Pay the balance each month and you’ll avoid interest charges and put yourself in a better financial position.
Should You Pay off Your Credit Card Balance?
Paying your balance in full is the ideal way to manage your money. By doing this you don’t run into a situation where your balance starts to grow and puts you closer to your credit limit.
When the balance is paid and that payment is made on time, it can only help improve your credit scores. Why risk bumping up against your limit and paying interest on your balance?
Make the Most of Your Rewards Card
Your credit card issuer likely gives you rewards for the purchases that you make. These rewards typically in the form of cashback or points that can be redeemed for gift cards, travel, etc.
These rewards are one of the benefits of having credit cards. Getting paid with cash back or other rewards provide an incentive to use your credit card over your debit card.
But if you regularly have a balance on your card, you will discover that this benefit disappears. Your credit card issuer will actually be the one to make money when this happens.
Compensation may completely be eaten up by the interest charges you accumulate on leaving a balance on your credit cards. It makes no financial sense to use a credit card to revolve a balance to earn these rewards.
How to Improve Your Credit Score
If you want to work on increasing your credit score, there are many ways to do this while staying interest-free and not accumulating balances. Below are some tips for how to improve your credit score that are based on sound finance advice.
Don’t Pay Your Bill Late
Making on-time payments makes up the biggest ratio in the calculation of your credit score. A clear sign to lenders that you would be a risky borrower is that having a spotty payment record. They will discover this information when they pull your report from Experian or another credit bureau.
So do everything in your power to prevent making a late payment on your credit cards. Here’s a good financial tip: Sign up for auto-pay services. There’s no cost to do this and it’s a standard feature that credit cards have.
Only Apply for Credit Cards when You Need Them
Another page from the book on improving your credit score is to open credit cards only when there’s a good reason to. For example, if you have a high credit balance that’s over 30 percent of your credit limit. Opening up another card could make sense in these cases to improve your utilization rate.
Another reason that you might want to apply for a new credit card is that it offers an intro balance transfer rate that will save you money. Make a plan to pay off that balance before the intro rate ends because the interest rate afterward is usually very high.
If you’re a few months away from taking out a loan for a big purchase like a home, you should stay away from applying for credit cards. Each time you apply for a credit card, a hard inquiry will appear on your credit report. This will ding your credit score and may impact whether you’re approved for a mortgage loan and the terms you get.
This also happens when you apply for a loan. If you want to search and compare interest rates, most lenders will allow you pre-apply, which is a soft pull. This won’t affect your credit as much but Experian recommends applying with these different lenders within a short time frame (less than a month) so it doesn’t impact your credit.
Don’t Close Old Accounts
How long your history with credit is another important factor of your credit score. That first credit card you got over ten years is actually more useful to keep open.
Even if you haven’t used your oldest accounts in years, leaving them open and in a drawer collecting dust is better than closing them out.
Use Free Credit Score and Monitoring Services
Routinely monitoring your credit is a good way to keep on top of changes in your credit score. Luckily, you don’t need to search very far to access this information. It’s a free feature that’s offered by many credit cards. If you don’t have a credit card or yours doesn’t offer one, Experian offers this service for free as well.