It’s more than likely that you’ve heard the advice to keep a balance on your credit card. Well-meaning parents, friends, even bankers and advisors may tell you that keeping a balance on your card proves financial responsibility and usage.
But the truth is that keeping a balance is not necessary to build your credit.
This is a huge myth that costs a lot of people a lot of money in interest, and also a lot of points on their credit.
What is a “balance?”
To make sure we’re clear, let’s explain what we mean by “keeping a balance.” A balance on a credit card is simply the amount you still owe. If you make the minimum payment, the balance is what is still owed after the payment is made. This is also the amount on which you’ll pay interest if a balance rolls over into the next billing period.
Most people believe that keeping a balance shows that you’re using the card and keeping your utilization ratio low, proving good financial habits. And while this is true, it also doesn’t hurt your score to pay it off in full, after you’ve received the billing statement.
Paying the balance in full is less important than the balance at the time of a credit report pull. It’s about the debt utilization ratio, so while paying in full is a smart financial practice, if you’re maxing out your card each month but paying it off in full, you’re still damaging your score.
However leaving it completely unused is also harmful to your credit, as it does nothing to prove your financial responsibility or ability to make timely payments. And there’s a chance that your account will be considered inactive and closed by the credit company because they are not making any money off of your inactive account. This is why it’s better to use your card, but keep your usage low and pay it off each month.
What if you need to use it more?
The ideal credit utilization ratio is 30 percent or less, with less being better. In fact, those with the highest credit scores, in the 750-850 range, have an average debt utilization ratio of about 7 percent. But it’s okay if you need to use more than 30 percent, as long as you pay it down to beneath the 25-30 before the due date and the reporting date which shortly follows. The balance on the credit card statement is what will be reported to the credit bureaus, so make sure your balance is paid down below 30, and as low as possible, before the due date so it reflects positively on your credit.
The best practice
Use your credit card regularly, but try to keep your utilization ratio below 30 percent. Know your budget and the amount you can pay off in full, and don’t spend more than that on your credit card. Once you get your credit card statement, immediately pay it off in full to avoid late payments, interest charges, and excessive debt.