Does Carrying a Balance Help Your Credit?

If you’ve ever tried to buy a home, take out a car loan, or borrow money to start a business, you already know how important your credit score is. Without a good credit score, it can be difficult to achieve any number of adult milestones, most of which can have a direct impact on your quality of life.

Unfortunately, the confusing way credit scores are determined can obfuscate the markers of good credit. We all know that paying bills on time is important, but a whirlwind of hearsay and credit myths convince people they should jump through all kinds of hoops — and even carry debt — to improve their scores over time. But, can carrying a balance actually improve your credit?

How Are Credit Scores Determined?

Before we tackle this issue, let’s discuss how scores are determined in the first place. Using the FICO scoring model, credit scores can fall anywhere between 300 and 850, and are decided based on the following criteria:

  • Payment history: 35%
  • Amounts owed: 30%
  • Length of credit history: 15%
  • New credit: 10%
  • Types of credit: 10%

As you can see, the most important factor is your payment history — as in, how you handle your monthly payments. If you always pay your bills on time, you’ll fare well in this category. And if not, your credit could take a hit.

The second most important category is the amount of money you owe, also known as your credit utilization. This is figured as a percentage of what you owe in comparison to your overall credit limit. For example, if your credit limit is $10,000 across three credit cards and you owe $1,500, your utilization is 15%.

Your credit length refers to the average length of your credit history across all accounts, while “new credit” refers to the number of accounts you have applied for in recent history. The mix of credit types you use matters, too: Overall, lenders like to see more than one type of credit in use. Types of credit can include mortgage loans, auto loans, personal loans, credit cards, student loans, and other types of debt.

Can Carrying a Balance Help Your Credit?

Here’s where things get tricky. With so many different credit scoring models, it can be difficult to figure out exactly how your utilization will affect your credit score.

heavy burden statue
You needn’t bear the burden of a credit-card balance to build credit. Photo: Josh James

Still, it’s safe to say that keeping your utilization as low as possible — and even at zero — will benefit your credit score the most. Most experts recommend keeping your utilization rate under 30% to avoid a negative impact on your credit score.

To show utilization and responsible use, you don’t need to carry a balance from month to month — the purchases you make factor into your utilization, too, even if you pay them off at the end of the month.

For example, if you charged $500 on the first of the month and paid it off on the 15th, your average balance for that 30-day period would be roughly $250, even though you paid your balance in full. So your best strategy is just to use your card regularly and pay your bill in full every month.

When you’re trying to build credit from scratch, a secured credit card or unsecured card with a low limit can help you prove your creditworthiness. To prove your worth, plan on using your card for small purchases you can pay off right away. Using your credit consistently — and responsibly — can improve your credit without the interest that results from carrying long-term debt.

The Simple Dollar’s Tips for Good Credit

Here are some tips that can help you build credit — or improve your existing credit score — over time.

  1. Use a credit card for small purchases and pay it off. To show you can use credit responsibly, use your card for small purchases you can pay off right away. If you don’t have a starter card yet, it might be time to shop for one. For your consideration: Best Credit Cards of 2020
  2. Make all of your payments on time. Whether we’re talking about credit cards, auto loans, rent payments, or any type of revolving debts, it’s essential to pay your bills in full and on time, every single time.
  3. Open new accounts sparingly. Since new credit can impact your score in a negative way in the short term, you should only open new accounts when it’s necessary, and try to avoid opening new credit cards when you’re about to apply for an important loan such as a mortgage.
  4. Don’t close old accounts. Since the length of your credit history is based on an average of all of your accounts, you should leave old accounts open as long as possible provided they aren’t costing you money in fees.
  5. Keep your credit utilization as low as possible — and definitely below 20%. In the past, FICO has noted that utilization below 20% is considered good, but that a number below 10% is better. Aim for a utilization rate of zero if you hope to stay out of debt and avoid paying interest on your purchases, which you should.

No matter where you are in life, your credit score matters. Fortunately, there are a slew of ways to improve your credit score without carrying revolving debt or jumping through hoops. As always, the best way to build credit is to do it slowly over time through responsible and regular use.

The most important thing to remember is to only use credit to buy what you can afford to pay off right away, and to pay your bills on time or early every single month. If you can manage that task, your credit score will easily take care of itself.

How did you build credit at first? Did you ever carry a balance in an effort to improve your credit?

Holly Johnson

Contributing Writer

Holly Johnson is a frugality expert and award-winning writer who is obsessed with personal finance and getting the most out of life. A lifelong resident of Indiana, she enjoys gardening, reading, and traveling the world with her husband and two children. In addition to The Simple Dollar, Holly writes for well-known publications such as U.S. News & World Report Travel, PolicyGenius, Travel Pulse, and Frugal Travel Guy. Holly also owns Club Thrifty.