Five Reasons to Pay Off Your Credit Balances Every Month

Credit health is a dynamic balance of debt, spending and financial management. While some balances are meant to be repaid over a long period of time, allowing others to linger can result in serious problems for your budget and credit score. In the case of revolving credit card balances, carrying long-term balances poses several risks, ones you can’t afford to ignore. Consider the following reasons to pay your credit card balances in full every month. What you learn could save you years of struggle and lost income.

Long-term credit card balances are damaging when it comes to:

1. Credit utilization. The immediate threat that comes with high credit card balances is utilization. The amount you owe vs. your total credit limit accounts for 30 percent of your overall score. Even if you make minimum payments each month, a high utilization ratio — 30 percent or greater — can cost you. Utilization isn’t limited to one card, either. For example, suppose you have three credit cards:

Card A: $2,000 balance/$4,500 limit=44.4 percent ratio
Card B: $1,500 balance/$3,000 limit=50 percent ratio
Card C: $1,000 balance/$10,000 limit=10 percent ratio

Total Balance/Total Credit Limit=48.6 percent Overall Ratio

Although Card C’s balance is well within safe utilization limits, the cumulative ratio is another story. Paying off your balances each month protects your credit by ensuring a healthy utilization ratio and manageable debts.

2. Debt-to-income ratio. Although DTI ratio isn’t a factor in credit scoring, the expenses associated with it play a major role in scoring. Mortgages, car payments, student loans, child support and minimum credit card payments affect DTI ratios and credit scores alike. When securing a new loan, lenders prefer applicants with a DTI ratio of 36 percent or less. If your DTI is too high, your chances of finding new credit are slim. Help your score and your DTI ratio by eliminating credit card balances from the equation.
3. Accruing interest. Credit card balances carried month to month are subject to accruing interest. For example, suppose your Visa card has a $5,000 balance with an 18 percent interest rate. Interest does not accrue on the balance until the day after the payment is due. If you choose to pay in full, you owe zero interest. If you choose to make a minimum payment, however, interest will accrue on the remaining balance. Suppose you decide to use the latter option, making a minimum payment of $100. While there are many equations to determine monthly accruing interest, APR is assessed generally assessed using a Daily Periodic Rate (DPR) equation:

(APR/365 Days Per Year) x Remaining Account Balance x Days Per Month=Daily Interest
(0.18/365) x $4,900×31=$74.91 Interest Per Month

After interest accrues, your monthly minimum payment will barely cover $25 of the principal balance, which means that your debt will continue to accumulate and weigh you down for years. Consider paying off your debt as soon as possible to avoid unnecessary interest. If you can’t afford to repay the entire balance, try to cover the minimum payment and monthly interest.

4. Buying options. A low DTI ratio and manageable credit balances add up to one thing: buying options. As we’ve learned, lenders rely on both DTI ratios and credit scores to assess an applicant’s risk level. High balances could mean an outright rejection, and even moderate debt could spell higher long-term interest rates for mortgages, auto loans, private student loans and insurance premiums. Once again, eliminating credit card balances is the shortest path to avoiding additional costs.
5. Without careful attention, debt has the power to overwhelm your financial resources. In the example above, a $5,000 credit card balance paid at $100 per month would take nearly eight years to repay. You’ll also spend $4,311 in interest payments alone. Don’t let credit card debt prevent you from moving forward and making positive changes. Talk to a professional about your goals —they can help you develop a budgeting strategy that will protect your credit and put your life back on track. It’s never too late to make a lasting change.

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