What Effect Does Paying off My Credit Card Balance Every Month Have on My Credit Score?

You may have heard that credit card companies will “ding” your credit report if you pay off your balances, harming your credit rating. This is simply untrue. One of the best ways to improve your credit score over time is to keep your credit card balances low (this goes for other “revolving” credit accounts too).

What is Credit Utilization Ratio?

The reason for this is that 30% of your FICO credit score is calculated using the “amounts owed.” This makes it the second most important criteria after payment history. So keeping low balances helps because the credit score formulas use a “credit utilization ratio,” which is the current unpaid balance on your accounts divided by the credit limits on those accounts. In other words, credit utilization is simply how much of your credit limit you’re using. The higher your credit utilization, the lower your credit score. The opposite is also true — reducing your credit utilization ratio will eventually increase your credit score (everything else being equal).

Obviously, there are two ways to reduce your credit utilization: by paying off your balances or by increasing your credit limit (if you can do both, you’re even better off). Don’t be fooled into thinking that closing accounts will help; canceling established credit cards that are in good standing will hurt your credit score because it will decrease your overall credit limit.

Another very good — and obvious — reason to pay off your balances is that it’s the best way to live within your means and avoid paying high interest rates on balances that just eat up more of your hard-earned cash.

So, the lesson here is to pay off your credit card balances every month. It should help your credit score and keep more money in your pocket. And higher credit scores should result in lower interest rates for credit.

Tags: credit score, credit utilization, credit utilization ratio

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