Does Carrying a Balance Affect My Credit Score?

One of the most common misconceptions about credit card debt is that you have to carry a balance in order to build and maintain a great score. To set the record straight, that simply is not true.

What’s in a credit score?

First, understand the formula that makes a credit score. The biggest part of your FICO score (the score most commonly used) is based on your payment history (35%) and your debt utilization ratio (30%). Other influencing factors are the average age of all of your accounts (15%), inquiries (10%) and credit mix (10%).

Each of the three credit bureaus (Equifax, Experian and TransUnion) provides FICO scores, and since the information on your file can differ from one credit bureau to the other, all three scores are likely to be slightly different.

You also have a VantageScore. This rating was developed by the credit bureaus to compete with FICO and is calculated in a similar manner. While VantageScore will not reveal its algorithm, the company does say that payment history is the single most influential factor, followed closely by the total amount of money owed, then age and type of credit, and the percent of used credit (utilization ratio).

Two biggest influences on your credit score

The payment history part of a score is most heavily focused on the last two years. If you always pay bills on time, you will do well in this category. If you missed a payment due date by a day or two once, your score won’t suffer much. By contrast, if a payment is sixty days late, your score will suffer a bigger hit. If any payment was ninety days late or an account went to collection status, the damage is considerable. So, the degree of lateness matters very much, as does the number of late payments.

The debt utilization ratio is the amount owed compared to the amount of credit available. Let’s say you have three credit cards and the limits are, respectively, $500, $3000 and $7000. Your total available credit is $10,500. Let’s also assume that your balances are $150, $2800 and zero. Your total debt is $2950, for an overall utilization rate of about 28%. That’s a good number. But watch out for card #2, which is at 93% utilization. If any one card is maxed out or close to it, your score is in danger of dropping. It’s better to spread out the debt among multiple cards so that no one card shows high usage.

Will carrying a balance boost or lower my credit score?

Carrying a balance does not boost credit score. In fact, large balances lower your score if they result in a high debt utilization ratio. Furthermore, VantageScore considers the total dollar amount of debt and recommends that consumers reduce the amounts owed. A low dollar amount and a low ratio are important for a healthy VantageScore. The less owed the better.

The best way to use a credit card to boost your credit score

A credit card helps build credit if it is used and paid off regularly. But there’s a catch. The card issuer reports your balance to the credit bureaus on the statement’s closing date, not the payment due date. So, if you always pay on the due date, your score could suffer even if you pay off the entire balance each month.

Here’s how it works. Let’s say your credit card has a $500 limit and you tend to use up all or most of the limit every month. If the balance is $490 on the statement closing date, your utilization ratio will be reported as 99%! You get no credit score benefit from paying off that balance on the due date. (You do, of course, get the benefits of no interest charges and no debt.)

If, on the other hand, you pay off the balance before the statement closing date, rather than waiting for the payment due date, your utilization will be reported as zero. Results: same card usage, same payment, distinct credit score advantage.

Consumers who can’t afford to pay off their balances completely every month should keep utilization as low as possible, and spread the debt among multiple cards to avoid maxing out any one card.

What’s the magic utilization ratio? Frankly, zero. But it’s a sliding scale. Keeping the ratio under 30% helps build a healthy credit score. Consumers with outstanding credit scores (760 or higher) tend to carry debt that is no more than about 7% of their available credit.