Many people use credit cards to help manage their monthly finances, but when their statements arrive, some will naturally ask, will paying my credit card balance every month help my credit score? The short answer is yes, but how much you pay, and when you pay will affect your credit score in different ways.
How credit cards work
When you get a credit card, you’re essentially given an interest-free loan for at least 21 days. As long as you pay off the entire balance by your statement date, no interest will be charged. However, if you don’t pay the full amount, interest will be applied to your purchases, which can be costly.
How paying your balance every month affects your credit
Equifax and TransUnion, the two credit reporting bureaus in Canada, look at how you use credit to determine your credit score. For most people, using a credit card is the quickest way to build their credit score.
One of the biggest factors that affect your credit score is making your payments on time. Whether it be the full amount or a partial payment, credit bureaus want to see you consistently making your payments on time. One missed payment usually won’t affect your credit score, but two missed payments in a row could greatly impact your credit score in a negative way.
Another consideration is your credit utilization ratio. That’s the amount of credit you’re using relative to how much credit you have available. For example, let’s say you have a credit card with a limit of $1,000, and you normally charge about $200 a month. That means you have a credit utilization ratio of 20%. Generally, you want to keep your credit utilization ratio under 30%.
Does carrying a balance help my credit score?
There are some people that believe you need to keep a balance on your credit cards to maintain a good credit score. The thinking is that if you’re always making your payments in full and on time, then the credit bureaus aren’t actually seeing any activity. This could potentially have a negative impact on your credit score. This is a misconception, as keeping a balance is not required to help your credit score. In fact, you likely want to avoid keeping a balance.
Credit cards typically charge an interest rate of 20% to 24%. If you’re constantly carrying a balance, you’d be ruining your budget since you’re paying interest every month. In an ideal situation, you’ll always pay off your bills in full each month.
Other reasons to avoid carrying a balance on your credit card
Besides the belief that carrying a balance on your credit card will help your credit score, there are a few other times when people intentionally carry a balance. They do it because they think it’ll help them, but the following reasons should be avoided:
To earn rewards
Many credit cards over travel rewards or cash back. There’s no denying that earning enough points to take a business class flight can be appealing, but that doesn’t make sense if you’re carrying a balance. Simply put, the interest you pay will always cost you more than any rewards you’re earning.
To pay for a large purchase
Since credit cards give you more purchasing power, many people use them to make large purchases. For example, a vacation or home renovations. If you’re unable to pay off the entire balance each month, you’re actually costing yourself more money due to the interest charges.
Does it ever make sense to maintain a balance on your credit card?
Occasionally, there are times when it makes sense to keep a balance on your credit card. If you’re ever in a cash crunch, using your credit card to get you by is a reasonable temporary solution. That said, in an ideal world, you’ll have an emergency fund to draw from so you can avoid any interest charges.
Another situation where it might be beneficial to carry a balance is if you have a credit card with a low interest rate. These credit cards typically come with a balance transfer option with a promotional low interest rate. For example, you might be able to transfer an existing balance to your new credit card with an interest rate of 0% for 10 months. By doing this, you’d pay less interest in the long run.
The bottom line
When used responsibly, credit cards can be a useful tool that can help you build your credit score. That said, if you’re maintaining a balance, it could be costly. One alternative is to consider KOHO, a prepaid card. Since you need to load funds in advance, you’ll never spend more than you have available. If you want to improve your credit score, you can always add the credit building feature.
Barry Choi is an award-winning personal finance and travel expert. He regularly appears on various shows in Canada and the U.S., where he talks about all things money and travel. His website - Money We Have - attracts thousands of visitors daily, looking for the latest stories on travel and money.