You might already be familiar with the fact that your credit score impacts several critical areas in your financial life. A higher credit score can help you to lock down lower interest rates, better mortgage deals, and can even help you to snag an apartment. That being said, does carrying a balance on your credit card help or hurt your credit score?
What does it mean to carry a balance?
First off, what does carrying a balance even really mean? By definition, when you carry a balance on your credit card it means that you’ve used a portion of your pre-approved credit to make purchases that you haven’t paid back yet. Essentially, that means you’ve swiped your card and in doing so borrowed money from your credit card company. Your balance can last for just a day or two if you pay it off immediately, or it can last for months (or even years) is you don’t pay it off. Additionally, if you don’t pay it within the first billing cycle, you’ll face interest charges. A balance can be any amount, from a small charge (like a $2 coffee) to a purchase that uses your entire credit limit.
Do you need to carry a balance to build credit?
What seems like a fairly simple question is one that continues to confuse consumers who are looking to build up their credit responsibly without going into credit card debt. The conundrum exists in the details: to carry a balance means to carry debt. Paying off debt can help you to build credit. But consumer debt is also the very thing that gets so many into trouble when they can’t make payments or are challenged by high interest rates.
The question is: If paying off a loan or debt can help to increase a credit score but you don’t want to take on (more) debt – are you required to carry a balance (and take on debt as a result) in order to maintain a healthy credit score?
The truth: you don’t have to carry a balance to have a great credit score. Paying off your balance in full each month (without carrying it over to the next month) can help you strengthen your score and also saves you from paying interest charges.
When you can pay off the balance at the end of each billing cycle you theoretically prove to lenders that you’re a responsible borrower and demonstrate that you can make timely payments. As a result, you increase your credit-worthiness and can benefit from a higher credit score as a result. That being said, your credit score is compiled of several other elements (age of accounts, amounts owed, types of credit, etc.) and not simply by credit card usage. Companies don’t need to see a high balance but they do want to see that you can make on time payments.
The Not So Good
Carrying a balance on your credit card that you can’t pay off each month will result in interest charges and puts you in danger of potentially lowering your credit score. Late payments will count against you, especially if they go past 30 days. Then, they’re entered onto your credit report as a negative mark.
In addition, carrying a high credit card balance can hurt your credit score. Most financial institutions recommended that you spend no more than 30% of your credit limit to remain within a positive credit utilization ratio.
Using a balance to build your credit score
The middle-ground in building credit without putting yourself in debt or hurting your credit score lies in two key elements:
- If you do use your card to help build credit, remain below the recommended credit utilization ratio.
- Pay the balance in full each payment cycle.
Remember: when you carry a balance on your credit card it indicates to a bank or lender that you’ve also entered into an agreement to pay off a balance. Even zero interest cards need to be repaid despite their “perk” of no interest charges. Never take on unnecessary debt.
Other ways to boost your credit
It’s a pervasive myth that you need to accumulate debt in order to raise your credit score. Though using credit responsibly can help you to boost it there are several other ways to improve your credit score without using your credit card.
- Reporting your rental payments
- Paying student loans/mortgages/other installment loans in a timely manner
- Keeping older accounts open to lengthen an account history
- Increasing your credit limit (without spending it!)
Another option if you’re just beginning to build your credit is to opt for a low interest credit card and diligently pay small balances off in full before the billing cycle ends. To be clear, these should be purchases that you feel 100% comfortable paying off. Paying off small balances immediately allows you to solidify responsible borrower habits while also building up your credit. Remember, this is only beneficial if you actively pay off any charges incurred. You’re still responsible for any money borrowed, regardless of a low interest rate.
Though credit cards can help you build up a higher credit score, your total financial security depends on your ability to pay off your balances or your credit cards and remain in control of your money. Don’t take on unnecessary debt or carry a balance just for the sake of raising your credit score. If you’re currently paying off debt, consider utilizing other ways that can help raise your score without taking on more debt.
Image Credit: Dennis van Zuijlekom