Paying off your credit card all at once can raise your credit score by reducing your credit utilization. However, if you’ve received a financial windfall, consider saving a big portion of it instead of paying off a big balance.
Dear Keeping Score,
I’ve gotten a hold of a large sum of money, enough for me to pay off credit card bills. What will benefit my credit score the best? Paying them all off, or continue to pay them off monthly? If continued to be paid off monthly, increase the amount I’m paying per month? Or stay paying it a little over minimum each month? Thank you for your time.
Dear “Flush with Cash,”
Congratulations on your windfall. I’m a little curious about how you ended up with a large balance on your cards that you just couldn’t pay off, but kudos to you for thinking about what will be best for your credit score.
Not everyone would be as astute. However, before you take any action I want you to take a deep breath and look at this windfall as a chance to improve your life, not just increase your score or lower your interest payments.
So, what should you do? Sure, you could just use your windfall to clear the balance off your cards. That would be great for your score and it would please your accountant, due to interest payment savings, but it might not be the best action you could take to balance your credit score with your life, financial and otherwise.
By paying your cards off you will immediately decrease your credit utilization down to zero and get access to 100% of your available credit. Since credit utilization counts for 30% of your FICO score and is second only to paying your bills on time, your score should see a fairly immediate jump.
But what happens next month or the months after that? I suggest that you take a look back at what caused you to end up with a balance so onerous that it took a “large sum of money” to dig you out. I also want you to consider what would happen next month if an unexpected large expense showed up. Would you be forced to carry a large balance again and have your score suffer after only a brief respite?
See related: How to increase your credit limit
Does carrying a balance help your credit score?
You may have heard that you should carry a small balance on your cards to help your score, but that is simply not true. The FICO algorithm will not punish you for not carrying a balance on your cards. Not having a balance or paying one off in full is just fine with the score.
However, along those same lines, if you simply bring your account balances down to about 20% or less you will see a credit score increase. You can then try to pay off the remaining balance over the next six to nine months. My concern is that without a plan to pay the cards off entirely, you may just keep a balance longer than you need to.
Consumers with excellent credit scores almost universally have credit utilization ratios in the single digits. So, keep that in mind. I would not suggest you continue to just pay a little more than the minimum on your cards. This is going to cost you more in interest payments and won’t have much of an immediate impact on your score.
See related: How to pay off credit card debt
Build up your emergency fund
The bigger question for you may be what happens after you pay down your cards. So, here’s what I suggest you do. See how much you will be able to reduce your balances using half of your windfall. If you can drive your balances down below 15% of your credit lines I’d stop there and use the other half to establish an emergency fund.
Without an emergency fund, the next big expense will put you back in the unwanted position of using your cards again to pay for it and then carrying a big balance from month to month. This is both expensive and bad for your score. At 15% or less, your balance won’t hurt your score and you’ll have cushion to handle emergencies.
I can’t stress strongly enough how important it is to begin to save for a rainy day or just some goals you want to achieve. Without savings you are constantly at the mercy of fate and you will not be financially secure or successful.
I also want you to estimate your spending and your income so that you have a handle on what is coming in and what is going out each month. Build into that spending plan something for savings. I recommend starting with just a few dollars per pay period if that’s all you can do.
When another windfall shows up put half of it in savings and keep half out to reward yourself. This is money you don’t have now, so you won’t suffer at all if you save half.
This can be a bonus, tax refund or stimulus payment, a raise or inheritance. Whatever it is, save half. In no time you’ll have a big cushion and money to fund your goals, and you’ll look and feel like a financially secure and savvy person.
When should you pay your credit card bill?
As you know, on-time payments account for 35% of your FICO score. There are a number of theories about the best way to pay your credit card bill.
One of those is to make several payments throughout the month. Another is to immediately pay off large purchases. Both are certainly valid, but remember that however you decide to make your payments, the most important thing is to be sure those payments in full are received by the date they are due each and every time.
As a side note, the only real reason to be concerned about a large purchase is if you are planning to apply for new credit within a few months, since a very large purchase can affect your score quickly by increasing your credit utilization. In that case, paying off that purchase immediately might be the prudent thing to do. You will have the money available, right?
Remember to keep track of your score!