Should I Pay My Credit Card in Full?

Highlights:

• It's a good idea to pay off your credit card balance in full whenever you're able.
• Carrying a monthly credit card balance can cost you in interest and increase your credit utilization rate, which is one factor used to calculate your credit scores.
• If you're under financial stress and can't afford to pay your credit card balance in full, it's best to pay as much as you can each month.

A credit card can be a great way to break large purchases into smaller, more manageable payments. However, carrying a credit card balance from month to month isn't generally the smartest option.

Is it better to pay off my credit card in full?

You may have heard that carrying a balance from month to month is good for your credit scores, but this is a common misconception. In reality, there are a number of reasons you should pay your credit card balance in full whenever you're able.

First, if you carry a balance, you'll pay interest on that amount, which can quickly get expensive. Credit card lenders generally charge an annual percentage rate (APR) ranging from 16% to 25% on purchases made with the card. Plus, most credit card interest is compounded daily, meaning any interest accrued on what you owe immediately becomes part of your principal balance. In effect, you're paying interest on your interest. As time passes, and you incur daily compounded interest, your debt will continue to grow — even if you don't make additional purchases.

Second, the balance kept on your credit card account can impact your credit utilization rate, which is one of the factors used to calculate your credit scores.

What is credit utilization?

Your credit utilization rate—also known as your debt-to-credit ratio—represents the amount of revolving credit you're using divided by the total credit available to you. Revolving credit accounts include things like credit cards or lines of credit where you can reuse credit (up to a predetermined limit) as you pay your balance down. This ratio, generally expressed as a percentage, is one of several factors that lenders may consider when calculating your credit scores.

Most prospective lenders are looking for a debt-to-credit ratio at or below 30%. A lower ratio may be seen as an indication that you're a responsible debtholder, while a higher ratio marks you as a risk and could lower your credit scores.

How credit utilization impacts your credit

When you make a large purchase with your credit card, your credit utilization rate generally increases. As you work to pay off the balance due on the money you've borrowed, the ratio will then usually decrease.

If you're carrying a balance on your credit card from month to month, you're increasing the odds that additional purchases will tip you over the 30% credit utilization rate that lenders like to see. When this happens, it's likely that your credit scores will be negatively affected.

Carry a balance only when you need to

If you're under financial stress and can't afford to pay your credit card balance in full, it's best to pay as much as you can each month. Any amount will help to reduce the amount of compounded interest you'll end up paying.

Find extra dollars wherever you can by making a meticulous budget and trimming your discretionary spending. You can also look for alternatives to using a credit card to fund expensive purchases. For example, you may be able to qualify for a personal loan, which typically has a much lower interest rate and fees than most credit cards.

When to pay off your credit card to increase your credit score?

Paying off your credit card debt each month is one of the most consistent ways to help improve your credit scores. But when in the month is the best time to pay your bill? The answer will depend on your unique financial situation, but here are a few things to consider:

• Paying ahead of your due date. It's a good idea to pay off your debts before your credit information is shared each month with the three nationwide consumer reporting agencies — Equifax, TransUnion and Experian. This practice helps keep your credit utilization rate low. However, the frequency with which card issuers report information can vary from lender to lender, and many cardholders are unsure of their reporting date. By paying your debt shortly after it's charged, you can help prevent your credit utilization rate from rising above the preferred 30% mark and improve your chances of increasing your credit scores. Paying early can also help you avoid late fees and additional interest charges on any balance you would otherwise carry.
• Paying your debts multiple times per month. Similarly, making payments toward a large debt multiple times in one month may be beneficial to your credit scores by helping you reduce your credit utilization rate.

Regardless of when you make your credit card payments, the most important thing is to pay what you owe in full before the due date each month.

When to think about a balance transfer

If you're struggling with high-interest credit card debt, you can consider a balance transfer.

A balance transfer shifts your existing, high-interest debt onto another credit card with a better interest rate. Balance transfer credit cards usually have a very low or no interest rate for a short period of time after you open the account. This introductory rate allows you to put more money toward paying down the principal amount of your debt and less toward compounded interest.

However, balance transfers aren't a good choice in every situation and should generally be used only if you are trying to manage significant, high-interest debts. You'll still have to treat your balance transfer credit card like any card in your wallet: Pay as much as you can afford toward the balance each month, and always pay on time.

Be aware of potential downsides, too. For example, some introductory interest rates are only available for a short period of time, and there may be limits to how much of your debt you can transfer to the new card.

Also, when you apply for a balance transfer card, your lender may run a credit check that could result in a hard inquiry on your credit reports. Hard inquiries help lenders track how often you have applied for additional credit accounts and may temporarily lower your credit scores, so it's important to apply for new accounts only when you need them.

Credit cards are a hefty responsibility, and credit card debt is no joke. But armed with the right information, cardholders can borrow — and repay — confidently.