A common question that many cardholders may ask themselves at least once is: Should I pay off my credit card balance in full each month or over an extended period?
Despite what you may have heard through the grapevine, it’s always better to pay off your entire balance — or credit debt — immediately. Not only will this save you time and money, but it’ll reflect well on your credit score.
Read on for more detail on why you should pay off your credit card in full, what credit utilization is, and how it impacts your credit score.
How does credit utilization work?
Credit utilization refers to how much money you borrow with your card each month. Every card has a predetermined credit limit, and your bank statement shows the amount you use to make purchases as a percentage.
Credit cards are a type of revolving credit, meaning that you can repeatedly borrow funds from your credit card company, pay them off, then borrow money again over a prolonged period.
Typically, credit cards come with a higher monthly credit limit, which is both advantageous and a drawback. You can borrow more to make larger purchases, but the temptation to spend more than you need to is always there since you aren’t technically spending your own money until the billing cycle comes around. Making the minimum payment ensures that you aren’t collecting credit card interest.
Is it better to pay your credit card balance in full each month?
There are certainly some benefits to having various loans and making repayments. It diversifies your credit portfolio while showing to banks, credit card issuers, and other lenders that you’re capable of handling money. But keeping a credit card balance isn’t ideal. If you can, it is always better to pay off your credit balance in full.
Paying the entire balance each month helps you maintain a good credit score or boost a low score, especially if this good behavior is frequent.
If you don’t pay off your balance entirely during a given billing cycle, also known as making the minimum credit card payments, that unpaid portion appears in your next monthly payment. It incurs interest and can quickly compound into a large fee if the balance is left unpaid for some time.
Eventually, your interest charges may be more than your original balance, which harms your credit score. Some cards have lower interest rates, so make sure you know the terms of your credit line or bank account.
How credit utilization affects your score
According to FICO and VantageScore, two of the most popular credit scoring models, credit utilization accounts for 30 percent of your overall score. It’s the second most significant factor in calculating your credit score after payment history, which accounts for 35 percent.
Your balance-to-credit limit ratio illustrates your utilization in a numerical value. This is determined by dividing your total credit card balances by your total available credit.
The lower your credit utilization, the better your credit score. Experts recommend keeping your utilization under 30 percent to avoid overspending, as well as to avoid additional penalties like late fees.
What helps your credit score the most?
As mentioned, credit history and credit utilization are the biggest factors affecting your credit score. Prioritizing these two aspects is crucial, especially if you're looking for approval for a new line of credit in the future.
Other things that help build credit are:
One: Ordering your free credit report. This is one of the first things you should do. If you don’t know what your score is, you can’t take steps to fix it.
Two: Bring any past-due accounts current. Pay off any late payments or payments that you’ve missed entirely (and their subsequent fees) as soon as you’re able.
Three: Apply for credit only when you need it. Each time you submit a credit application, lenders make what’s called a hard inquiry into your credit. This action remains on your report for two years. Multiple hard inquiries lower your score, so don’t apply for every type of credit that comes along. Think carefully about your goals.
Why is the due date so important?
Paying off your entire balance by the payment due date will see your credit score go up. Otherwise, your credit issuer could charge you a late fee, and your credit score could suffer — especially if you miss paying off multiple cards.
According to data gathered by Experian, Americans carry an average of over $6,000 of credit card debt incurred from unpaid balances as of 2020. Consistently paying off your balance may seem overwhelming, especially if you’ve missed payments before or haven’t had the means in the past. But don’t fret. Many strategies can help address this.
One simple, straightforward way to keep yourself out of credit card debt is to equip yourself with the right card.
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