Yes and no. There is certainly something to be said for living debt free. Having no loan payments. Not worrying about an outstanding balance accruing interest and late fees every month. Avoiding the dreaded collection agency call. But the truth is, very few of us live without some form of debt.
Even the most financially frugal cardholder can carry some sort of credit card balance—paying the minimum and additional interest when the monthly bill comes due. If you have the funds, is it in your best interest to pay off your credit card balance in full? And in the end, is it even feasible to do so most of the time? And how does paying in full or covering just the minimum affect your overall credit score and future finances? First things first.
What is a credit card balance?
It doesn’t take an accountant to figure out what a credit card balance is and how it grows over time. Simply stated, when you make a purchase with your credit card, you essentially borrow money from the card. The amount you charge becomes your credit card balance. The more you use the card, the higher the balance.
Every month, your credit card company sends a bill for the full balance, but also lists the minimum acceptable payment to avoid late fees. This amount varies, as some credit card issuers charge a set percentage of a cardholder’s balance, while others add interest and fees from the previous pay period.
How do credit card payments work?
As the Consumer Financial Protection Bureau states, credit card lenders make most of their money from the interest customers pay on their balances. It is actually in the lender’s best interest if you pay the minimum each month, because they keep the accrued interest. But paying the minimum works against you since you could end up paying thousands of dollars in additional interest.
The minimum payment you end up owing is calculated in three ways:
- As a flat percentage of your balance.
- As a changing percentage of the balance you owe, plus interest fees from the prior month if you have any.
- As a flat rate. In this case, the lender charges the same flat rate each month with the proviso that the card’s balance is kept under a certain amount.
The card issuer may employ one or more of these calculation methods depending on your standing and whether interest has been accrued or late payment fees incurred.
Fortunately for you, the CARD Act of 2009 directs card issuers to provide transparency to cardholders. They are required to show how long and how much it will take for you to pay off a balance if only minimum payments are made.
How Much And How To Pay?
You can pay any amount on your credit card bill that works for you, although paying less should be avoided when possible!
Some ways to pay your bill include:
- Dropping the money off directly to the branch of the bank that your card is drawn under or the card’s merchant location.
- Mailing in a check with a return of your monthly bill.
- Through a payment app
- By using online bank payments
Please note that some payment methods include a nominal fee.
Paying Late
Paying your credit card balance late or not paying it at all can get you in hot water. Some consequences include:
- Incurring late fees
- Getting an increase on your card’s interest rate.
- Seeing your APR rise (the annual percentage rate you are charged. This could result in an increase in the future minimum payments your lender will take each month from you.
- Putting a blemish on your credit score
The Pros of Paying In Full
By paying off your full credit card balance each month, you avoid any possibility of paying additional interest due to an increased APR. You could also, over time and with an on-time payment record, bolster your credit score. There is a good chance you will also see an increase in your credit card limit as your lender comes to see you as a top-tier customer.
The Cons of Paying In Full
Consider these scenarios: Your home radiator blows, and it needs to be replaced. The family car needs a sudden, costly repair. You take an emergency flight to visit a sick relative. These sudden, costly credit card charges can come at the most inopportune times. But some purchases are necessary, no matter how much they cost and how much you can afford.
While these expenses could mean your finances will take a hit for the month and possibly a little longer, trying to pay for such a pricey purchase in full could be a daunting task. So, letting your credit card take the brunt of a high-priced purchase and paying that high balance off slowly is better than paying nothing at all.
What Is Credit Utilization?
Credit utilization is the amount between the current outstanding balance on your credit card and what your lender has set as your spending limit on the card. As you can imagine, carrying a balance from month to month makes it more difficult to keep your credit-utilization profile low.
But lower credit utilization is what we should all be striving for. The rule of thumb is to keep your balance below 30% of your overall credit card limit; this will show the lender that you are a good customer. Paying your balance down, or off altogether, can boost your credit score by lowering your credit utilization ratio.
Charging for card usage
Some card companies charge an annual fee to use their card. This amount can differ drastically from lender to lender. But there are often credit card perks associated with signing up for one card as opposed to another. It is up to you to see if the card’s perks are valuable to you even after you subtract the yearly fee.
These perks can include:
- “Cash back” rewards
- Travel rewards
- Hotel discounts
- Airline lounge access
- Pre-paid TSA Prechecks
The truth about 0% credit cards
The American marketplace fosters heavy competition between credit card companies. Due to this, many lenders offer 0% credit cards for a set amount of time. Interest will eventually kick in after the offer expires, which a lender clearly states in all their contracts and advertisements. But these kinds of cards are great to use if you know you have a pricey purchase and you can pay off the debt before the interest rate skyrockets.
In addition, a 0% credit card can help you consolidate balances from other cards. Why pay high interest rates if you can pay off those balances without interest and save money? Again, make sure you can pay off the balance before the interest rate goes up.
Paying off a balance in full makes the most financial sense, whether it is your gas credit card or a bank-issued monthly credit card bill. But for many of us, all we can afford to pay is the minimum amount the lender is willing to take. Rolling a balance over to the next month should be avoided at all costs. But if you have no other choice, try to pay off the debt as soon as possible.