What do you think about keeping a balance on your credit card or line of credit? According to certain people and some corners of the Internet, it’s a smart financial move that builds credit. But can you trust them?
In reality, this mistaken belief is based on a misunderstanding of how these revolving accounts contribute to your score.
Let’s examine why this belief is so tenacious before shedding light on why it’s actually not a good idea. This article will debunk the myth and provide you with the facts you need to make informed decisions about managing your credit card debt.
The Misconception: Building Credit Score
The main reason why people think it’s beneficial to carry a balance on their credit cards is the belief that it helps improve their credit score. The theory suggests that having an ongoing balance demonstrates responsible credit usage and boosts your creditworthiness.
In reality, your credit score is determined by various factors, including payment history, credit utilization ratio, and length of credit history. And as you’ll find out below, carrying a balance may negatively impact your utilization ratio.
What is Your Credit Utilization Ratio?
The credit utilization ratio refers to the percentage of your available credit that you’re currently using. It is one of the most significant factors in calculating your credit score, second only to payment history.
A high ratio — in other words, a high balance — does not factor favorably into your score. It suggests you may be facing financial difficulties, so you can see your score drop when you consistently carry a large balance.
Ideally, you should try always keep your ratio as low as possible and never exceed 30%.
The Reality of Interest Expenses
One of the primary drawbacks of carrying a balance on your credit cards is the interest charges that accrue.
A lender like Fora only charges interest on the draws that you make against your line of credit. That means you don’t have to worry about accruing interest on your entire limit.
However, you will accrue interest on your withdrawals for as long as they remain in your balance. These fees compound every month you carry over a balance, so you’ll pay more for every purchase you don’t pay off in full.
Interest has the power to eat into your budget, making it harder to pay off your debt and limiting your ability to save or invest wisely. So, it’s important you pay off your balance in full to reduce these extra costs.
Why You Should Pay Your Accounts in Full
The best practice when it comes to managing credit card debt is to pay your balances in full and on time each month. By doing so, you avoid unnecessary interest charges while demonstrating responsible credit usage. Paying your balances in full not only saves you money but also allows you to maintain a healthy credit utilization ratio, positively impacting your credit score. You’ll also keep these accounts free in case you need to use them in an emergency.
What Are Your Next Steps?
If you currently have a credit card or line of credit balance that you’re struggling to pay off, it’s important to develop a debt management plan. Start by making a budget that cuts unnecessary expenses and allocates more funds toward paying down your credit card debt. Consider strategies like the debt avalanche or debt snowball methods to tackle your balances systematically. Seeking professional advice from credit counseling agencies can also provide valuable guidance and support.