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

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In a perfect world, as I see it, no one would ever carry a balance on a credit card. Carrying balances usually means you are paying interest on your purchases, so whatever you bought ends up costing you more than it needs to.

Even in the case of low or no-interest promotions, carrying debt always represents a risk. Depending on how high your balances are in relation to your credit limit, you may also run the risk of damaging your credit score.

Does keeping a balance help your credit score?

Carrying a balance does affect your credit score. The size of that impact depends on how large of a balance you’re carrying compared to your credit limit. Credit utilization, or the amount of available credit you have used, is an important factor in your credit score. Second only to payment history, it counts for about 30 percent of your total FICO score. VantageScore uses a weighted scale and calls this part “extremely influential.”

How credit utilization works

Here’s a simple illustration: you have a credit card with a $500 limit and you use $250 to make a purchase. Your credit utilization ratio is 50 percent. This is going to be bad for your credit score. Conventional wisdom says you need to use no more than 30 percent, or $150, to keep from losing points in your credit score. Keep in mind that this is the total amount you should spend in one billing cycle on this card.

Chances are you have at least one more credit card, so we have to take that into account as well. Let’s say the second card has a $1,500 limit and you have used $400. This puts you between the 25 percent and 30 percent utilization ratio on this card. This is important because while each card will be counted separately, they will also be combined to come up with a total.

Overall in this example, the utilization rate is 26.25 percent (1500 + 500 = 2,000 total credit; 125 + 400 = 525 total used; 525/2,000 = 26.25).

How credit utilization affects your credit score

At 30 percent utilization, you will effectively maintain the status quo on your credit score. Moving down to 25 percent could result in an increase in your score. The lower you can go, the better it will be for your score, assuming all of the other factors that go into your score are in good shape.

So how low are we talking here? Those who enjoy the best credit scores typically have utilization factors in the single digits. But remember that they are also doing all of the other things right—they are paying their bills on time, watching their utilization, not closing old accounts to maintain their credit history, have a good mix of both revolving and installment accounts and only open new accounts as needed.

Is it better to pay in full or carry a small balance?

Paying your balances in full every month demonstrates that you are living fully within your means. In other words, you are not using credit cards to extend your income, but as a way to spend the income you already have. This is the best sign of overall financial health.

Some high credit score achievers may carry a small balance (think single percentage points) in order to demonstrate that they are using the credit they have been given. There is a school of thought that says this is necessary to show they use their credit in a responsible way.

The key here is to know when your credit card issuer reports your account information to the credit bureaus. In many cases, that will be at the end of your billing cycle. Your balance on that day will be what’s reported to the bureaus, and it will be factored into your credit utilization. So, in theory, you could keep a small balance on that date and then pay it off the next day to show some account activity and avoid interest charges.

Hitting 1 percent seems to be the holy grail here. However, I am not a fan of chasing the “perfect” score, and trying to get to 1 percent may be a lot more trouble than it will ultimately be worth.

When carrying a balance hurts your score

One reason not to carry a balance is that you are likely to incur interest charges. But there are credit cards that offer a low or even 0 percent introductory interest rate. These are most often for a specific period of time, typically 12-15 months. Carrying a balance on a card like this may make good financial sense, but it also comes with increased risk.

For example, as long as life is treating you well, there’s no problem. If you lose your job, get sick or have any one of a number of reversals of fortune—that can be a big problem. You may be stuck with a large balance you can’t pay and end up making late payments, which hurts your score.

Also, remember that the utilization factor will still be in place, so you should be prepared for what that might mean for your score. It could still be worth it to you, depending on your situation. I would say you need to weigh your choices carefully here, but do what is best for you and your family.

Best credit cards for carrying a balance

If you need to carry a balance, be sure to use a credit card with a low interest rate. Currently, the average credit card interest rate is just over 16 percent, so anything lower than that is considered a low interest rate. Even better, choose one with a 0 percent intro APR offer as well. Here are a few of our top picks:

Citi® Double Cash Card

  • Best for: Flat-rate cash back
  • Intro APR: 0 percent for 18 months on balance transfers
  • Regular APR: 13.99 percent to 23.99 percent variable
  • Annual fee: $0
  • Rewards: 1 percent cash back as you buy, plus another 1 percent when you pay for your purchases

Discover it Cash Back

  • Best for: Rotating cash back categories
  • Intro APR: 0 percent for 14 months on purchases and balance transfers
  • Regular APR: 11.99 percent to 22.99 percent variable
  • Annual fee: $0
  • Rewards: 5 percent cash back on up to $1,500 in purchases each quarter on rotating categories after you activate, then 1 percent

Petal® 2 “Cash Back, No Fees” Visa®

  • Best for: Students, those with little credit history
  • Intro APR: N/A
  • Regular APR: 12.99 percent to 26.99 percent variable
  • Annual fee: $0
  • Rewards: Earn 1 percent on eligible purchases or up to 1.5 percent cash back on eligible purchases when you make 12 on-time payments, plus 2 percent to 10 percent cash back at select merchants.

The bottom line

Reporting a balance on your cards of more than about 30 percent of its maximum credit line will hurt your score and carries additional risks. The lower your balances, the better your score, and a very low balance will keep your financial risks low. But the best way to maintain a high credit score is to pay your balances in full on time, every time.

How you choose to use the credit that is given to you is always up to you and your own personal situation. But knowing how your choices affect both your credit score and your overall financial health is smart.

Good luck!

Have a credit score question? Drop us a line at the Ask Bankrate Experts page.