A common misconception about credit is that you need to take out a loan carry a balance on your credit cards and pay interest to build your credit score. The truth is that you can build a strong credit score without ever paying a cent in interest or fees.
When it comes to credit cards, paying your credit cards off in-full every month, by the due date is the best way to use your credit cards to increase your credit score.
Let’s take a quick deep-dive into how credit scores are calculated and how this works.
How your credit score is calculated
The credit score that most lenders use is some variant of the FICO score. Here’s how your FICO score is calculated.
- 35% – Payment History – Have you made payments on-time? Or do you have late payments? (Paying all of your credit accounts on time is the single biggest thing you can do to get a good credit score.)
- 30% Amounts Owed – How much of your credit are you using? Are you maxing out your cards every month, or are you using only a small amount of your available credit lines? (Using less of your available credit is always better.)
- 15% Length of Credit History – How long have you been using credit? What is the age of your oldest account? What is the average age of your credit accounts? (As you build your credit history, this factor naturally gets better.)
- 10% Credit Mix – What kinds of credit accounts do you have? Do you have different types of credit accounts? (You can have an excellent credit score with just a single credit card. You can have an excellent credit score with just a car loan. Don’t worry about this too much.)
- 10% New Credit – Have you opened a lot of new credit accounts recently? (Lenders are looking for people whose situation might have changed and who might become at risk of default. If you’re looking for a lot of new credit in a short period of time, that might raise an eyebrow.)
As you learn more about credit, you’ll find that there are many variations of FICO and other credit scoring models, but they largely rely on the same factors. Don’t worry about the details too much. As long as you’re keeping the above factors in mind, you’ll be effectively managing all of your credit scores.
How balances impact your credit
To better answer the question if you need to carry a balance to build your credit, let’s look at how carrying a balance on a credit card impacts the factors in your FICO score.
Payment History: Pay on time, every time.
Payment history is the largest factor in your credit score. What creditors are looking for in your payment history is consistency in making payments on time. As long as you make at least your minimum payment by your due date, you’ll get credit for an on-time payment.
But if you pay off your credit card in full every month, you’ll also get credit for an on-time payment and you won’t have to pay any interest. This means you can establish a solid payment history without ever paying interest on a balance.
Even better, simply keeping a credit card open helps your payment history, even if you don’t charge anything during the month. Every month that your balance is $0, you get credit for an on-time payment.
As an example, here is how the payment history reports for a credit card that I’ve had open for the last seven years. Most months, I don’t use this credit card at all. In the image below, “C” means “Current/On-Time.”
Although I use this card once a year (when the card offers me a discount on something I’d buy anyway through Citi Merchant Offers) it reports on-time payments to my credit report every month.
The bottom line: As long as your credit card is open and has either a $0 balance or you make at least a minimum payment before your due date, it will report as “current,” which improves your payment history. If you pay it off in-full every month, you get credit for an on-time payment and you don’t pay any interest.
Amounts owed: Owe as little as possible for a higher score
The second largest factor in your credit score is the amount you owe on your credit accounts. Paying your credit cards in full every month is the best thing you can do to improve this factor in your credit score. All other things equal, having lower balances means a higher credit score.
Even if you pay your credit card in full every month, your credit report might show a balance. For example, here’s how my Citibank credit cards show up on my credit report. One of my cards shows an amount owed, even though I pay it off in full every month. This is because most credit cards report the balance when your statement closes.
With most credit card issuers, you can pay your account before the due date to get them to report a $0 balance to your credit reports. But as long as you are using less than 30% of your available credit, this likely isn’t worth worrying about.
Bottom line: The less you owe on your credit cards, the better your credit score. Carrying a balance will only hurt the “amounts owed” part of your credit score.
Other factors
The remaining 35% of your FICO score involves length of credit history, credit mix, and new credit. These factors don’t really relate to the balances on your cards, so carrying a balance cannot help improve these factors.
Bottom line
You do not need to carry a balance or pay interest to establish an excellent credit score. Even keeping a card open with a $0 balance reports on-time payments to your credit reports each month.
The best thing you can do with your credit cards is to pay them off in-full every month by your due date.
Frequently asked questions
The need to carry a balance to improve your score is a popular myth, but it simply isn’t true. All other things equal, paying off your credit cards every month will provider a bigger boost to your score than carrying a balance. This is partly due to how credit scores are calculated. Your credit utilization, or percentage of your available credit that you’re using, plays a huge rule in your score. When you pay off your balance, your credit utilization is lower, increasing your score.
Carrying a balance on your credit card will earn your bank more money, but it won’t improve your relationship with your bank. With respect to credit cards, the biggest thing your bank cares about is that you’re paying on-time, every time.
Your credit score might take a noticeable hit once you use north of 30% of your available credit. While your score will recover within a month or two once you pay off your balance, using less than 30% of your available credit on any given credit card will minimize the impact of your balance on your credit score.