Credit card users can find themselves looking for every trick in the book to improve their credit score. The biggest and the best way is to pay the balance in full and on time each month.
Lesser steps can help also, but the small improvement may not be worth the effort. Or worse, they can backfire.
A good example of this is if a credit card should be paid off completely each month, versus leaving a small balance to show the card is being used regularly.
Why leave a balance?
Always having a balance on your credit card can be taken as a sign that you’re using the card often, which can be a good thing. But it can also be seen as having money problems because you can’t pay your debts off regularly.
Of course, there’s a difference between a $5 balance and one that’s $100 or thousands of dollars. Either way, you’re paying interest on it — unless you pay it before the due date, which is essentially paying it off on time. Credit scores favor recent activity or usage, so using a card regularly should help a credit score.
If it’s a credit card you rarely use but want to keep as a backup, then leaving a small balance or charging a small amount each month is a sign of an active account and won’t cause the card issuer to cancel the card. If it is canceled, that could cause a credit score to drop by having too few sources of credit open.
A zero balance can indicate a lack of recent activity on the card. A zero balance could also be the result of a highly active card user who pays the card off each month.
Why pay off carry over debt
Paying a credit card balance off each month is one of the best ways to raise a credit score, and more importantly, it doesn’t cost you in interest paid on the balance. Payment history is the most important factor in credit scoring, whether you pay on time or not.
Your credit utilization rate is the second-most important factor in your credit score. This is the ratio of your balance to your credit limit. The lower utilization rate, the better your credit score will be.
Leaving a low balance each month increases the utilization rate, though a few extra dollars won’t hurt it too much.
The best utilization rate is 30 percent, meaning you’re not carrying a balance of more than 30 percent of your credit limit on one card or in total. Lower balance will improve a credit score. Keeping the balance well below a credit limit is a good sign that you consistently manage debt well, and can improve credit scores.
How to deal with balances
If you’re going to leave a balance on your credit card solely because you expect it to raise your credit score — again, this is mostly a myth — there are ways to make sure it doesn’t affect your credit utilization rate.
If your credit card balance goes above 30 percent, you can lower it by paying off some of the balance before it appears on your next credit card bill. You can increase your utilization rate to as high as your credit limit and it won’t hurt your credit score if any amount over 30 percent utilization is paid “early.”
That means the charges are paid off within the same billing cycle that they’re charged in. When the next statement balance appears on a credit report, it will be below the 30 percent recommended limit if paid early.
Leave a small balance and test it
If you want to see if having a small balance will add a few points to a credit score, give it a test run. Here’s how:
Pay the balance in full one month so that you have a zero balance. Wait about 30 days for your credit reports to update at each credit bureau. Then get one or all three of your FICO credit scores, which are used most often, though each bureau uses different score versions.
A month later, compare by leaving a balance of $5 or so. Repeat the above process. During this time, be sure not to do anything different with your credit that could affect your credit score — such as opening new credit accounts or paying late.
You should then be able to see if your credit score goes up with a small balance.
The biggest downside to small balances
As stated earlier, carrying a credit card balance will ding you with an interest charge. That may be worthwhile if it’s only a few dollars. But it could cause a snowball if you forget about it — and we’re not just talking about increased interest payments.
Suppose you decide not to use the card anymore because you’ve gotten a better credit card with a higher limit and better rewards. You don’t want to close the first card because you want to keep the extra credit limit to improve your credit utilization ratio.
But then you forget about the old card with the small balance and don’t pay the $5 bill. A month later the account could become delinquent, which could stay on your credit report for seven years and lower your credit score by 60 to 110 points.
That’s a big risk for possibly gaining a few points on a credit score.
The best solution may be to pay off the balance by the statement due date. If you’re really anxious about keeping the utilization rate below 30 percent, then pay off new charges during the current billing cycle.
The bigger steps, not the small ones, should lead to better credit scores and ultimately to better credit card offers with higher limits and lower interest rates.