By LOUIS DENICOLA
There's a common credit myth out there that could be costing you money. Many people believe that carrying a balance on their credit card will help them build credit. However, the reality is that carrying a balance doesn't necessarily help your credit, and could actually hurt your credit score.
Katie Brewer, Certified Financial Planner™ (CFP®) and president of personal finance coaching site Your Richest Life Planning, has heard this myth from people of all ages and education levels. Brewer says, "Many people get their information from family and friends and never think to do their own research."
Here's why carrying a balance is generally a bad idea.
What does carrying a balance actually do?
Some people mistakenly think that carrying a balance will help their credit score because card issuers earn money from them in the form of interest payments. However, the amount of interest issuers earn from you doesn't affect your credit score. Your credit scores are typically determined by other factors, such as percentage of on-time payments.
What actually happens when you carry a balance is you'll start to accrue interest based on the annual percentage rate (APR) of your card. If you have a zero-interest introductory offer you won't be charged interest for a specified period of time. However, once the APR kicks in, you'll be subject to paying interest, which is around 15 percent on average for all credit cards, on any new or remaining balance.
In addition, there can be negative effects to your credit. Carrying too high a balance could result in a high credit utilization rate, or the percentage of your total credit limit that you're currently using, which in turn may lower your score. Generally, you should aim for a credit utilization rate of less than 30 percent. So if your credit limit is $10,000, your total balances would be less than $3,000.
You don't need to carry a balance to keep a card active
Brewer thinks that some people may be misinterpreting the advice they're given -- confusing "showing lenders you're using credit" with "having a balance." While regular use and timely repayments help show lenders that you're a responsible borrower, consumers can prove their creditworthiness without having to pay a penny of interest.
Keeping a card active is important, but there are many ways to do this without carrying a balance. One of the simplest may be to use your card to automatically pay a small recurring expense - such as a subscription to Netflix - that you pay off monthly. Some checking accounts can be set up to pay the credit card bill in full when it's due, automating the whole process.
If your card remains inactive, the issuer could close the card or stop reporting the card's activity to the credit bureaus. If this happens, that card's limit likely won't be included in your overall credit limit. Then if your usage or balance remains the same, the percentage of the available credit you're using (your utilization rate) would increase, which could negatively impact your credit score.
If the issuer closes the card, the average age of your open accounts may also decrease which could potentially hurt your score, as your length of credit history is another factor that can be used to calculate your credit scores.
Is carrying a balance ever a good idea?
The short answer is probably not, but in reality that may not always be an option. A credit card can be a helpful last resort during an emergency, such as needing to repair a vehicle so you can get to work or paying for a visit to the doctor. But, you may want to consider the potential long-term effects.
David Weliver, founding editor of Money Under 30, a personal finance blog, says, "While a month's worth of interest may not seem like much on a small credit card balance, if you don't pay the balance off in a month or two, your total interest starts to add up fast." Weliver knows from personal experience - his small credit card balance ballooned into tens of thousands worth of debt.
Carrying a credit card balance might be necessary at times, but it generally won't help you build credit and might end up costing you money. Consider charging at least one small transaction to your card each month to keep it active and then paying the bill in full.
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