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

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In a perfect world, 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 not help your credit score, so it’s always best to pay your balance in full each month.

The impact of not doing paying in full each month 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 not to use more than 30 percent, or $150 in this case, 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).

Want to quickly calculate your current ratio? Check out Bankrate’s credit utilization ratio calculator.

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, not closing old accounts to maintain their credit history, have a good credit mix 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 may carry a small balance (think single percentage points) in order to demonstrate that they are using the credit they have been given. Though none of the major credit bureaus say this is necessary or helpful, some consumers theorize that this demonstrates that you’re actually using (and paying off) your credit line each month.

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.

However, I am not a fan of chasing the perfect credit score, and trying to keep a small balance for credit score benefits may be 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 low interest credit cards and even 0 percent introductory APR credit cards. These are most often for a specific period of time, typically 12-15 months. Carrying a balance on a card like this may make 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.

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 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.

Written by
Steve Bucci
Credit and Debt Expert Contributor
Steve Bucci has been helping people decode and master personal finance issues for more than 20 years. He is the author of “Credit Management Kit For Dummies,” “Credit Repair Kit For Dummies,” “Barnes and Noble Debt Management,” co-author of “Managing Your Money All-In-One For Dummies” and “Debt Repair Kit For Dummies” (Australia). Steve is an experienced expert witness in identity theft, credit scoring, and debt-related cases. He has been a presenter at the FICO InterACT Global Conference, the Federal Reserve and the International Credit Symposium at Cambridge University in the UK.
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