Depending on your existing score, you may notice a slight increase in credit when you fully pay off a credit card. Getting rid of credit card debt is an incredible achievement, especially since credit card balances have been on the rise. According to the Federal Reserve Bank of New York, the total credit card balances for Americans has reached a series high at $1.03 trillion!1
When you pay off credit card debt, not having those monthly payments means that you can put money into other areas of your budget. Also, when your credit card balances go down, you may be expecting another important number to raise—your credit score. In addition to increasing your available funds, a zero balance can bring some overall improvement to your financial health. This blog will look at what eliminating your credit card debt can do for your credit score.
Understanding Your Credit Score
A credit score is what borrowers and lenders alike use to measure a person’s likelihood to pay back their loans. It is a rating that tells any financial institution or bank how risky it is to take you on as a borrower. Your credit score is based on the information in your credit report. A credit report is a detailed summary of how you have handled your accounts and your relationship with your creditors. A credit bureau compiles credit reports. These companies analyze information from businesses and financial institutions about your behavior as a consumer. The three major credit bureaus in the United States are Equifax, Experian, and TransUnion. If you have ever rented a home, bought a car, or applied for a loan, these agencies have a credit report on you.
Lenders and creditors determine the size of a loan, down payment, and interest rates through an individual’s credit report. This is why your credit score matters when it comes to borrowing money and being approved for credit cards.
If you have ever tried borrowing money with bad credit, you know just how important your score can be when it comes to getting approved for a personal loan. Everyone knows that having a high credit score is better than having a low one, but many people don’t know what makes up their credit score or the effects of having a bad credit score.
Five key factors go into calculating your credit score. Since we’re talking about credit card use in this blog, let’s start with the one most affected by the way your credit card activity is.
Credit Utilization Ratio
Utilization of credit is the percentage of how much of your available credit you are using. For example, if you have a $500 balance on a credit card with a $1,000 limit, your utilization of credit would be 50%.
Credit Utilization is one of the most impactful elements of your credit score. Specifically, a high utilization ratio can raise a red flag for a potential lender; it could read that you run up debt without a clear plan to repay it. Keeping utilization low will show a pattern of responsible credit use. People with excellent credit keep their utilization floating in the single-digit percentage range, but keeping it below 30% will help your score.
Here are the rest of the factors that make up your credit score, in order of importance:
History of payments are a record of all the financial installments you’ve made. From there, potential lenders can see how you repay borrowed money and if you do so on time. Along with your credit utilization rate, is one of the two most essential factors in your credit score. Like your utilization ratio, your payment history also answers questions about how you handle debt. If your history of payments is full of late or missed payments, it will weigh very negatively on your credit report. On the other hand, decreasing late payments is the best and easiest way to improve your score quickly. It matters so much to pay your bills on time.
Your credit history is a list of all your past and current credit accounts. History of credit gives potential lenders a summary of your financial relationships and provides indicators of future habits.
When you apply for a credit line, trying to get new lines of credit can harm your score. It may seem like getting more credit at the moment will help your situation, but it can make you appear to be in financial trouble.
A credit mix is a balance of different accounts that will show creditors you can handle payments. For example, personal loans like bad credit loans and credit cards are both paid back in different ways. Managing a variety of debt well can mean that you can responsibly take on more debt.
The credit bureaus calculate these five factors and release separate reports for every consumer, complete with credit scores. Credit scores range from 300-850 along the following scale:
- 300-579 Very Poor/Bad Credit
- 580-669 Fair Credit
- 670-739 Good Credit
- 740-799 Very Good Credit
- 800–850 Excellent Credit
Lenders usually view people with good credit as lower-risk prospects, so they may be more likely to receive personal loans or assistance at lower interest rates and better loan terms.
Accessing your credit report is easy. You can do so through each of the major credit bureau’s websites. Furthermore, you are entitled to a free credit report from at least one of the bureaus annually.
Types of Credit Card Payments and Your Credit Score
|Impact on Credit
|Transferring high-interest credit card balances to a card with a lower interest rate.
|Can temporarily decrease score due to hard inquiry.
|Multiple Card Payments
|Paying off multiple cards versus focusing on one at a time.
|Distributing payments can reduce overall utilization.
|Closing Old Accounts
|Closing credit card accounts that are no longer in use.
|Can decrease credit age, potentially lowering the score.
|Opening New Credit Accounts
|Applying for new credit cards or other lines of credit.
|Multiple hard inquiries can decrease the score.
|Increasing Credit Limits
|Requesting a higher credit limit on existing cards.
|Can decrease utilization ratio, potentially boosting score.
|Combining multiple credit card debts into a single personal loan with a fixed interest rate.
|Can improve score by reducing credit card utilization.
|Setting up auto-pay to ensure timely payments.
|Consistent on-time payments can boost the score.
|Seeking Credit Counseling
|Consulting with professionals to manage and pay off debt.
|Neutral effect. Doesn’t directly impact credit score.
|Legal process to eliminate or repay debts under the protection of the federal bankruptcy report.
|Significantly decreases the score for several years.
|Negotiating with creditors to pay less than what’s owed.
|Can negatively impact the score, showing settled status.
Is It a Good Idea To Pay Off Your Credit Card Debt?
It is, without a doubt, a good idea to pay off your credit card as soon as possible. If you were to pay off the $500 balance of your credit card, then your utilization of credit would be 0%. And since utilization of credit is one of the most important parts of your credit score, you should see a significant rise.
One persistent myth is that having debt will help you when you are trying to build strong credit. However, this is not true. You don’t have to pay your entire credit card balance to make some improvements to your credit score. Keeping your credit utilization below 30% can help you move your score in a positive direction. Whether you pay the credit card off or maintain a balance, remember that less is more!
Should I Cancel My Credit Card After I Pay It Off?
Now that you’ve got that credit card paid off, it seems like the best thing to do is get rid of it, right?
Well, not necessarily.
Canceling your card can have some effects—particularly on your credit reports—that you may not have considered.
Your Credit Utilization Will Decrease
Let’s take a look at your credit utilization ratio one more time. Canceling a card—while eliminating the possibility of credit card debt—will also decrease your available credit. Let’s say you have two cards, each with zero balances and a $1,000 limit. That would give you $2,000 in available credit. If you cancel one of those cards, your available credit would be just $1,000. That means that every credit card purchase will now have double the impact on your utilization. A $300 balance will now carry the same weight as a $600 balance in this example.
If you’re finding it difficult to avoid using more than 30% of your available credit limit, then applying for an increase to your card limit might be the solution. A higher overall limit could help lower your utilization, which means that it would make a difference to your score.
Your Credit History/Credit Age Will Be Altered
Canceling a card will eliminate it from your portfolio. That means that your credit history will shrink. And if you cancel your oldest card, your credit age will shorten.
You Will Change Your Credit Mix
Imagine that the only accounts on your report are your credit card debt and two installment loans (like your mortgage or car payment). If you were to cancel your card, you would only be managing one type of debt. Although your credit mix is the least impactful of your credit report factors (10%), it can mean the difference when straddling the line between good credit and bad credit.
So, while eliminating debt should always be a priority, you may want to consider how eliminating your available credit can negatively impact your financial health.
If I Don’t Want To Use My Credit Card, Why Should I Keep It?
Wanting to rid yourself of a possible debt creator like a credit card is understandable. But, there are a couple of great reasons to keep a zero balance credit card open:
If your score is already strong, the change in your credit won’t make a big difference. The effects of dropping a credit card from your report won’t change the access you would have to loans or other lines of credit.
If you’re planning on making big purchases, having an available line of credit can come in handy. Regarding car loans and mortgages, strong credit scores and available credit will help any approval process.
Even with those positives to consider, the reality of an open credit card can create a temptation to spend. If you struggle with spending, make it difficult to use the card. Store it in a safe deposit box or with a trusted friend or family member. Also, try to keep the card’s usage limited to only emergencies.
Other Ways To Improve Your Credit Score
Paying off your credit card is an excellent start to improving your credit score. If you want to keep that number strong, you’ll want to pick up these financial habits.
Dispute Credit Report Errors
Correcting your credit report can help to boost your score, as long as you can see the errors and get them fixed. Reviewing your credit report will give you a view of all your accounts. You will be able to spot any that were missed by reporting agencies in the past. You may be surprised to find accounts on your credit report that you’ve already settled or paid off since most people who see their report as part of a loan application will only do so once. Settled accounts listed as active ones can lead to inaccuracies in your score. Each major credit bureau and many free credit monitoring apps allow you to dispute negative information, which usually takes about 30 days. There’s no charge whatsoever for the process.
Pay Your Bills On Time
Who knew paying utilities can help build credit? It’s crucial to make all your recurring payments on time. That includes making your rent, utilities, and other bills by their due date. Late fees and penalties take lots of money and time to recover from. If you want a strong credit score, sticking to your due dates is the way to go.
If you pay your bills over a month late, the lender is legally entitled to report this fact to the respective credit bureau, which will negatively impact your credit score. Almost every lender or creditor is willing to negotiate, but they ultimately want to get back as much as possible. They’ll work with you to get their money back.
Build a Budget
As with many problems, recognizing the need to rebuild your credit score by identifying the issues on your credit report is an important first step. Securing and managing your available credit is an excellent second step. And the best way to keep that momentum going is by building a budget.
A budget is a plan for how you want to spend your money over a specific period. A personal budget should list how much money should go towards living costs, such as rent and food, and paying down debt. A lot of people create budgets that detail spending each month.
There are plenty of apps that will help you organize your spending each month and provide valuable features such as money-saving tips and paying off debt. But all that can sound intimidating at first. If you feel overwhelmed by the thought of building a budget, start small. Start by listing every bill you pay in any given month, along with the due dates and amount. Then write down the amount of money you make in a month.
By using this basic budgetary view, you’ll be able to collect valuable data that can help you figure out financial problems. For example, if you discover that you are making less than you owe, you can start to make plans to eliminate or decrease a For many, a budget will make the task of managing your finances a lot easier. But the budget can’t do the work all on its own. Plan time every week to make sure that your living costs are not exceeding the budget.
FAQ: Credit Scores and Paying off Credit Cards
Maintaining a low credit card balance can positively impact your credit score. A lower balance means a lower utilization rate, which is a significant factor in credit scoring models.
Yes, making multiple payments within a billing cycle can reduce your credit card balance faster, leading to a lower utilization rate. This can potentially result in a credit score increase.
A good credit score typically ranges from 670 to 739, though the exact range can vary depending on the credit scoring model used. Higher scores indicate better creditworthiness.
Your utilization rate represents the percentage of your available credit that you’re using. A lower rate (generally below 30%) is viewed positively by credit scoring models, potentially leading to a higher credit score.
Yes, paying off your entire credit card balance can lead to a credit score increase. It reduces your utilization rate and shows responsible credit management.
It’s recommended to use no more than 30% of your available credit. For instance, if you have a credit limit of $1,000, try to keep your balance below $300.
Yes, many credit card companies are open to negotiations, especially if you’re facing financial hardships. They might offer a reduced interest rate or a payment plan to help you manage your debt.
While the exact algorithms vary, most credit scoring models prioritize utilization rate and payment history. Keeping a low balance and making consistent, on-time payments are key factors across models.
Not necessarily. While making multiple payments can help reduce your balance, credit card companies typically report the ending balance of your billing cycle to one, or sometimes maybe more, credit bureaus.
Yes, having multiple credit cards can influence a lender’s decision. While it increases your overall credit limit, lenders also consider the potential risk of you maxing out all your cards. It’s essential to manage all cards responsibly.
A Word From CreditNinja About Credit Cards and Your Credit
If you pay off your card, the truth is that you will most likely see some improvements in your credit due to paying off your balances. What’s more, if you pay off a lot of credit card debt, you are more likely to experience an increase in your overall score.
But, CreditNinja wants you to remember that it may take weeks or even months to see your hard work reflected in your score. And if you want to continue making lasting changes, you’ll need to start applying good financial habits to every area of your life. When you budget effectively and use credit wisely, you will not only boost your credit score but keep it strong for years to come. Want to learn more about how to improve your finances? Check out the CreditNinja blog dojo for free articles, resources, debt calculators, and more!