How Carrying a Balance Could Affect Your Credit Score

Did you know that 43% of Americans are carrying a balance on a credit card, and nearly 56 million cardholders have been carrying that balance for over a year?

While you may find yourself in this situation at some point in life, it's essential to understand that carrying a balance may have a big impact on your credit score—a critical factor that lenders often consider regarding applications for loans, credit cards, and other financial products (it may even affect your ability to rent an apartment or secure a cell phone plan!)

If you're carrying a balance and wondering why your credit score may have dropped, this overview can provide an explanation and offer some strategies for regaining control of your financial future.

Note: If you need help rebuilding your credit, or are looking to build credit for the first time, meet Varo Believe1—our secured credit card with no annual fee, no credit check, no interest, and no minimum security deposit. On average, customers using the Believe card with existing credit see a 40-point increase in their credit score after 3 months of on-time payments2.

What is a Credit Score and How Does it Work?

Your credit score is a number between 300-850 that represents your creditworthiness (how likely you are to be able to repay borrowed money). Lenders, such as banks and credit card companies, often use your credit score to assess the risk of lending you money. A higher credit score can often indicate that you're a lower-risk borrower, leading to more beneficial loan terms, lower interest rates, or even higher approval odds.

What affects your credit score?

According to Experian, the following factors affect your credit score:

Payment history (35% of your FICO score)

This factor indicates how well you've done at paying your bills on time. Late and missed payments as well as collections could significantly damage your credit score.

Credit utilization (30% of your FICO score)

This is the percentage of credit you use compared to your available credit limits. High credit utilization—especially above 30%—could signal that you’re unable to meet your current financial obligations, which could in turn,  lower your credit score.

Length of credit history (15% of your FICO score)

How long each of your credit accounts have been open for.

Credit mix (10% of your FICO score)

The variety of credit types you have, such as credit cards, mortgages, and auto loans.

New credit inquiries (10% of your FICO score)

The number of new credit applications you've made recently.

How Carrying a Balance on a Credit Card Could Affect Your Credit 

Carrying a balance on your credit card means you have yet to pay off your full statement balance by the due date (typically 21 days after the statement has closed.) In these cases, your remaining balance is carried over, and you're charged interest on that amount. While carrying a balance might seem mostly harmless, it could impact your credit score.

One of the main ways carrying a balance could affect your credit score is its negative reflection on your credit utilization ratio.This ratio is calculated by dividing your total credit balances by your total available credit limit. For example, if you have a $1,000 balance on a credit card with a $4,000 limit, your credit utilization ratio for that card is 25%.

High credit utilization, particularly above 30%, may negatively impact your credit score because it could suggest to lenders that you may be financially overextended and possibly even struggling to manage your debt. Maintaining a low credit utilization ratio, under 30% (but ideally below 10% when possible), could help improve your credit score over time.

There's a common myth that carrying a small balance on your credit card can help your credit score. This may not necessarily be true. The Consumer Financial Protection Bureau (CFPB) outlines that paying off your credit card balances in full each month may be the best way to keep your credit in good standing.

Example of How Carrying a Balance Can Impact Your Credit Score

Let's say you have a credit card with a $1,000 limit and regularly carry a balance of $800, resulting in a credit utilization ratio of 80%. This high utilization could significantly lower your credit score. On the other hand, if you pay down your balance to $200 (20% utilization) or even $100 (10% utilization), you could see a noticeable improvement in your credit score over time.

While carrying a balance on your credit card might seem like a normal part of managing your finances, you can work toward a healthier credit profile by understanding how credit utilization works and striving to pay off your balances in full each month.

The Consequences of High Credit Utilization

When your credit score takes a hit, it could impact your ability to access credit in the future. Lenders may view your credit as higher-risk, making it more difficult to secure loans, mortgages, or additional credit cards with more favorable terms.

If you're applying for a mortgage with a low credit score due to high credit utilization, for example, you could face higher interest rates or even be denied altogether. 

A low credit score resulting from high credit utilization could also affect other aspects of your life, such as:

• Renting an apartment: Landlords often check credit scores to assess potential tenants' financial responsibility.

• Getting a cell phone plan: Cell phone providers may require a security deposit for those with lower credit scores.

• Applying for a job: Some employers, particularly those in the financial sector, may check credit reports as part of the hiring process.

Consumers with good credit and a FICO Score between 670-739 generally have a credit card utilization of about 35.2%.

Missed Payments and Credit Scores

In addition to high credit utilization, missed payments could also have a significant negative impact on your credit score. Payment history is commonly seen as the most crucial factor in determining your credit score, accounting for 35% of your FICO score.

When you miss a credit card payment, your lender may report it to the credit bureaus as a delinquency. This payment delay could stay on your credit report for up to seven years, potentially lowering your credit score and making it more difficult to access credit in the future. Even a single missed payment could cause a substantial impact on your credit score. For example, if you have a credit score of 780 and miss a payment by 30 days, your score could drop by as much as 90 to 110 points, according to FICO.

6 Strategies for Paying Off Your Credit Card

If you're currently carrying a balance on your credit card, don't worry—there are strategies you can implement to help pay off your debt and improve your credit:

1. Create a Budget

Analyze your income and expenses to identify areas where you can cut back and allocate more money towards debt repayment. Many people who successfully budget create a separate savings account specifically for paying off their credit card debt.

2. Set Up Automatic Payments

Many people find it helpful to set up automatic payments from their checking account, allowing them peace of mind that payments will be made on time each month. 

3. Consider the Debt Avalanche or Debt Snowball Methods

The debt avalanche method involves paying off your highest-interest debts first, while the debt snowball method focuses on paying off your smallest debts first for a motivational boost.

4. Look Into Balance Transfer Credit Cards

Many credit cards offer a 0.00% introductory Annual Percentage Rate (APR) period. By transferring your credit card balance from a high-interest card to one with no interest, you may  be able to pay them off without accruing additional interest for the length of the introductory term, which is usually about 15 months. However, it is important to note that these rates are often followed by higher-interest rates at the end of the introductory period. This strategy can buy you some time, but it’s still crucial to pay off this debt before the interest starts to rack up again.

5. Explore a Personal Loan

Personal loans generally have lower interest rates than credit cards, which could result in a potential reduction in the overall debt burden and savings on interest charges in the long run. Therefore, by consolidating all the credit card balances into one personal loan, you could simplify your repayment plan by having just one fixed monthly payment by combining your debts into one payment. 

6. Negotiate With Your Credit Card Issuer

When contacting the credit card issuer, you could discuss options such as reducing interest rates, creating a repayment plan, or even settling the debt for less than the full amount owed. For a positive outcome, it's important to be prepared with information about your own individual debt, understand the available debt relief options, and communicate your unique financial situation and needs.

Building and Maintaining Good Credit Habits

Developing good credit habits can be essential for long-term financial health. Some key habits to adopt may include:

• Pay your bills on time, every time

• Keep your credit utilization low by paying off balances and avoiding maxing out your available credit 

• Monitor your credit reports regularly and disputing any errors

• Be selective when applying for new credit to minimize hard inquiries on your credit report

• Maintain a healthy mix of different types of credit (e.g., credit cards, installment loans) to demonstrate your ability to manage various forms of debt responsibly

By incorporating these habits into your financial routine, you can work towards building and maintaining strong credit health over time.

Finding a Strategy That Works For You

Carrying a balance on your credit card could potentially bring down your credit score, primarily through high credit utilization. But, you can work toward a brighter financial future by understanding how credit scores are calculated and adopting strategies and effective tools.

The Varo Believe credit-builder card1 is great for those looking to establish their credit for the first time, rebuild poor credit, or simply add a new, consistent credit account to their portfolio. Set your own spending limit, use only what you have, and get your payments reported to all three major credit bureaus (without the debt that comes with traditional credit cards). The Believe credit-builder card offers no interest, no fees, and all credit histories accepted.

Get started today or click to learn more about the Varo Believe Card!

¹ Varo Believe is a secured credit card designed to help you build credit; however, a variety of factors impact your credit and not all factors are equally weighted.You must add money before using, money added sets the spending limit. Funds spent are held in your Varo Believe Secured Account to pay off any balance in full monthly, when due. Quals apply.

² As of November 18, 2024, customers who had an existing VantageScore® 3.0 credit score showed an average increase of approximately 40 points after three months using Varo Believe and on time payments. Individual results may vary, and some customers may not see a score increase.