How to Carry a Balance on a Credit Card and How It Relates to Credit Score
When you don't pay your credit card balance in full each month, you are carrying a balance. The balance you carry over each month can have an affect on your credit score, and paying down these balances may improve your credit score. That's why it's important that you manage your credit and debt effectively. If your score is lowered, you will have to pay higher rates of interest for credit products such as mortgages, credit cards, and auto loans. Also, carrying credit card balances can make your debt ratio too high.
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Instructions
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Determine if you are carrying credit card balances on any of your cards, and then look at the credit limit on each. A simplified example will explain it further. If you have a credit card with a credit limit of $10,000 and the balance is $0, your available credit is $10,000. Making a purchase of $4,000 reduces your available credit to $6,000, ($10,000 - $4,000 = $6,000). When your credit usage is 30 percent or higher, it starts to have a negative effect on your credit score. In this example, the credit usage is 40 percent ($4,000/$10,000 = 40%), which is not good for your credit score.
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Make a large payment on your credit card balance. A payment of $2,000 will reduce the previous balance to $2,000. Even though you are still carrying a balance from month to month, the effect on your credit score is positive because you are now using less than 30 percent of your available credit, ($2,000/$10,000 = 20%). You should see an eventual increase in your credit score as a result of the large payment.
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Evaluate the effects of lowering your credit limit. When you carry a balance and your credit limit is lowered by the credit card company, your credit score will be lowered as well. So, avoid lowering your credit limits if at all possible. If you have a credit limit of $10,000 and your outstanding balance is $2,000, your credit usage is 20 percent ($2,000/$10,000), which is good because you are not in danger of harming your credit score. When a credit card company lowers your credit limit, against your will, from $10,000 to $6,000, your credit usage goes up to 33 percent ($2,000/$6,000), which is not good because you have exceeded the 30 percent level for credit usage. Pay down your credit card balances so that your credit usage will remain below 30 percent, which contributes to a healthy credit score.
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So, carrying a balance may or may not affect your credit score negatively; it all depends on the relationship between the credit limit and the balance. This relationship is calculated for all of your credit cards. If you have ten credit cards, the balances are all added together and then compared to the total amount of your credit limits to get your credit usage.
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One of the factors that contribute to your credit score is the length of your credit file: the longer you have been on file with a credit reporting agency the better. When you close out your older accounts, they are no longer factored into the age of your credit file and your credit score is thus lowered. Once accounts are paid off, it is best to leave them open. According to Experian, closing accounts after they are paid off will reduce your available credit and increase your utilization rate, both of which can lower your credit score.
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Tips & Warnings
Paying off your balance and closing the account could actually lower your credit score.
