If you’re not already paying off credit cards in full each month, then you should seriously consider making this your next financial goal. Not only is it great for your credit score, but it will make you richer overall too (and we’ve got the math to prove it!)
You may not be doing this already because you’re finding it difficult to afford your repayments – and we can definitely help you work on that.
But some of you may have heard that not paying off credit cards in full is actually good for your finances. In particular, there’s a common story that carrying credit card debt actually helps your credit score.
Unfortunately, that’s not quite the case.
So we’re here to set the record straight regarding your credit card debt – as well as show you how you can kick it to the curb!
Can’t I improve my credit score by not paying off credit cards in full?
In a word: no.
Many people seem to think that you shouldn’t pay off the entire balance on your credit card when you’re trying to build credit.
But actually, it’s the opposite. In fact, one of the best things you can do for your credit score is paying off credit cards in full each month.
If you can’t quite manage that, you should pay off as much as you can – or, at the very least, you should absolutely be making the minimum payment by the due date.
Why? A little thing called your credit utilization ratio
Your credit utilization ratio is essentially how much you owe divided by your overall credit limit.
It’s based only on your “revolving credit”, which essentially includes credit cards and lines of credit. So things like your car loan or mortgage don’t factor into this.
As an example, let’s say that you have $20,000 in credit available over two credit cards with a balance of $8,000 on one and $2,000 on the other. This means that your credit utilization ratio is 50%.
When calculating your credit score, your credit utilization ratio makes up about 30% of this.
And the lower it is, the better your score will be.
Meaning that it’s far better to be paying off credit cards in full so as to have a balance of $0 against those two credit cards than the $10,000 imagined above.
This also means that if you have a credit card that you’ve paid off in full (congrats!), you should keep it open.
To use the above example, say the limit on each card is $10,000 for a total overall credit limit of $20,000.
But then you pay off the $2,000 balance and close that card, with the $8,000 balance still owing.
This means that instead of owing $8,000 on an overall credit limit of $20,000, you’ll now owe $8,000 on a $10,000 limit.
So your credit utilization ratio will be 80% instead of only 40%.
And when a higher credit utilization ratio is worse for your credit score…then that 80% figure isn’t great.
How much will paying off credit cards in full improve my score?
Essentially, it depends on how you paid it off.
If you pay off one card but keep a balance on your other credit cards, your credit score will improve a bit as your credit utilization ratio drops.
If you pay off your overall credit balance by chipping away at it over time, your score will also increase over time. Perhaps unsurprisingly, you won’t see a huge increase immediately, but it will improve more and more as you pay off more and more.
If you pay off your credit cards in full, this will cause the biggest improvement to your credit score as your credit utilization ratio drops to 0. Once your full repayment is reported to the credit bureaus, you’ll likely see a significant increase to your credit score.
Why paying off credit cards in full will make you richer
The other thing to keep in mind as to why you should be paying off credit cards in full is that it will save you a ton of money over time.
It’s been found that the average US household owes $16,883 in credit card debt.
Worse, each household is paying an average of $1,292 in interest each year.
That’s almost $1,300 that could definitely be spent on better things (like investing it to make you even more money)!
Not to mention if you’re getting hit with any sort of penalty fee, although this will show you exactly how to get bank fees waived.
But maybe you’re still not sure about paying off credit cards in full. If that’s you, you might want to think about the difference this can make to your overall financial situation.
Let’s assume that you hold the average individual American’s credit card balance of $6,375 which you’re paying off at an interest rate of 16.92%.
(This was the average credit card interest rate in the US at the time of writing this article, so that’s what we’re going to use here.)
Based on this, check out how much you’ll pay in interest depending on how much your repayments are AND how long you’ll be making those repayments for:
- If you pay off $100 per month, you’ll spend $9,990.50 on interest alone and it will take you 13.7 years to pay off
- If you pay $200 per month, you’ll spend $2,150 on interest and it will take 3.6 years to pay off
- If you pay $500 per month, you’ll spend $702.42 on interest and it will take just 1.3 years to pay off.
So paying only $100 per month is equivalent to paying around 1.5 times the total amount of your credit card balance just in interest.
In addition to having to pay the actual debt, of course!
But by doubling that to $200 per month, you’ll save almost $8,000 in interest payments.
And not to mention that paying off $200 per month on your credit card balance will save you ten years of repayments compared to if you only pay off $100 per month.
That’s pretty incredible in itself!
This is all because of the miracle of compound interest. If that sounds boring, prepare to have your mind blown by this article: THE ONE PRINCIPLE THAT WILL GUARANTEE YOUR FINANCIAL FUTURE
So when paying off credit cards in full can:
- Improve your credit score
- Save you literally thousands of dollars
- Avoid years or even decades of repayments
- Help you reduce the stress of having debt
…it’s a pretty good way to go!
If you’re not sure how to find that extra $100 each month, this article can definitely help: 30 CREATIVE WAYS TO MAKE $100 A DAY
Why using your credit card is good for your credit score
All this isn’t to say that you should never ever use your credit card.
The golden rule of having a credit card is that you should only use it if you can pay off the balance each month.
So even if you have a high credit limit, make sure you’re keeping your actual use of the card to a manageable amount.
At the same time, building credit involves showing your track record of using credit responsibly.
For credit cards, this means showing that you can put expenses on the card AND pay it off on time.
However, you shouldn’t pay off your credit card immediately each time you use it as it may show that you’re not even using credit.
Instead, you should use your card throughout the month (only up to an amount that you can pay off!)
Then, for the best result for your credit score, make one single credit card repayment at the end of the month just before it’s due.
What can I do so that I’m paying off credit cards in full?
If your credit card debt is too high at the moment for you to pay off in full, then you should absolutely be focused on paying off as much as you can as quickly as you can.
This is especially because your credit card debt probably has the highest interest rate of any other debts you owe, meaning it’s costing you way more over time compared to the amount of the debt.