Does carrying a balance help credit?

The way credit works may seem complicated. With multiple credit scoring models, three credit bureaus and myriad factors affecting scores and lending decisions, it’s no wonder the system seems confusing to many.

It’s also no wonder there are plenty of myths surrounding credit. You might hear that it will hurt your score if you check it. You might think closing a credit card is good for your credit. You might believe your work history or assets have an impact on your scores.

One of the most popular myths suggests that carrying a balance on your credit card can help your credit. It won’t. In fact, making a habit of carrying a balance can even hurt your credit score – and your financial health. Read on to learn why and what to do if you have to carry a balance.

Is it better to pay off your credit card or carry a balance?

It’s best to pay off your credit card bill in full – always. While it’s important to use your card regularly to maintain a relationship with your issuer, you can do so without revolving a balance.

Leaving a balance on your credit card won’t help your score. In fact, it may actually cost you some credit score points – not to mention the money that goes to interest.

“It’s unclear where the myth that carrying a balance on your credit card helps your credit score came from,” Anna Barker, personal finance expert and founder of LogicalDollar, says. “However, neither FICO nor VantageScore awards extra points if you carry a balance.”

How carrying a balance can hurt your credit

Your FICO credit score is calculated based on the following five factors:

• Payment history (35% of your credit score)
• Credit utilization (30%)
• Credit history length (15%)
• Credit mix (10%)
• New credit (10%)

Of these, credit utilization is the category in which carrying a balance can negatively impact your credit. Since it makes up 30% of your credit score, the damage might be significant.

Your credit utilization ratio is your credit card balance compared to that card’s limit, expressed in a percentage. For example, if you carry a $3,000 balance on a card with a $10,000 credit limit, your credit utilization ratio for that card is 30% – and you might want to lower it.

The general advice is to keep your credit utilization ratio under 30%. Anything higher might negatively affect your credit score. If you can’t pay your credit card bills in full, you should still try to keep that ratio in single digits – the lower, the better.

“Carrying a balance hints to lenders you are not capable of paying back your debts,” Ty Stewart, CEO and president of Simple Life Insure, explains. “Put more frankly, it says you don’t manage your money well, spending more than you make. Down the road, this dings your credit score and will make receiving favorable loans of any form harder.”

How carrying a balance can cost you money

Even if you’re keeping your credit utilization ratio low, carrying a balance is still expensive.

When you let your balance roll over to the next billing cycle, you start accruing interest. Since credit card APRs are high compared to other kinds of loans, credit card debt accumulates fast.

That’s especially true if you have a secured card or another type of card targeted for people who are building credit. Since consumers with lower credit scores can get approved for such cards, issuers mitigate the lending risk by charging interest rates that are typically well over 20%.

Moreover, if you have a rewards credit card, carrying interest can eat away at your rewards. Even if you have a generous rewards rate, it’s not a match to your credit card’s APR.

Consider the following scenario: You have a credit card with a flat 2% cash back rate and an APR of 18%. You charge $1,000 and get $20 in cash back, but you let that $1,000 roll over to the next month. On your bill, you’ll be charged approximately $15 in interest, bringing your rewards gains down to $5. If you continue to pay interest in the following months, your rewards may soon be outweighed by interest charges.

For that reason, if your goal is to maximize credit card rewards, paying your credit card debt in full every month is essential.

What to do if you have to carry a balance

While ideally you want to pay off every credit card bill in full, it might not be possible. There are valid reasons people choose to carry a balance, and it’s not always about not having enough cash. Maybe you’re working on building your emergency fund or financing a big purchase, or maybe you’ve had to cover unexpected urgent expenses.

If you find yourself with revolving balances on your cards, work to bring your credit utilization to 30% or lower to make sure your debt doesn’t hurt your credit.

To help your credit utilization, Barker recommends requesting a higher credit line. If you can’t drop your balance to zero, increasing your credit limit can be an easy way to lower your credit utilization ratio.

“Sign up for balance alerts,” Barker suggests. “Most banks offer a service where they can send you a message or email with regular balance updates. Signing up for these can be a good way to keep an eye on your credit card usage over the course of the month so that 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 that is to create a budget and determine the maximum amount you can dedicate to credit card payments. If the amount is too small, figure out how you can generate extra cash. For example, look for ways to increase your income or sell some items around the house.

“If you can find a way to make some extra money in a given month, you should put it toward paying off your credit card balance,” Matt Woodley, founder of Credit Informative, says. “This will give you more wiggle room in an emergency, and it will also help you cut the amount of credit you’re utilizing. Once your credit card balance is paid off, you’ll be able to use the money that was going toward that payment toward improving your financial future.”

At this stage, it’s also a good idea to look into credit card repayment strategies. You can try the avalanche method – where you pay down the credit cards with the highest APR first – or the snowball method, which suggests paying off the cards with the lowest balances so you can see the progress faster.

Whichever approach you choose, stick to eliminating your credit card debt. The sooner you get out of it, the less money you’ll lose to interest.

Bottom line

Among many credit myths, the positive impact of carrying a balance is one of the most common. The truth is, it’s best to pay off your balances in full every month to protect your credit and your financial health. Even when that’s not possible, try to keep your balances as low as you can, and look for ways to pay down your credit card debt. Your credit score will thank you – and so will your wallet.