When you find yourself at that point where you want to eliminate most of your credit accounts, you might think that your credit cards should be the first ones to go. While your intention of managing lesser debts is a sound decision, you must also keep in mind how such a move might affect your credit score.
It’s better to weigh on the advantages and disadvantages of paying off your credit cards. You may never know exactly how credit scores are calculated that the safest notion of paying off your credit cards might improve your score – but then again, it might not.
Why Credit Cards are Good Type of Credit to Keep?
You may be one of those who consider your credit cards like two-edged swords – they can make or break your credit. Not everyone with credit cards is successful in handling this type of credit account. But there are really good and practical reasons why you should keep them.
They build a credit history
Because of the frequency in using your credit cards, there are more credit reports sent by your bank and merchants to credit bureaus. It will build your credit history much faster and raise your credit score, even if you don’t have any other types of credits under your name.
They give you quick access to credit purchases and cash borrowing when you need them
You can purchase big-ticket items and pay them on installment, or tap on the cash advance feature anytime.
They offer cash backs and rewards on your purchases
As a loyal card user, you are rewarded in cash or kind that both translate to savings. They come with an expense tracker to help you manage your spending
Card companies keep your record for years and give you access to it so you can see your spending patterns. This extra service may come useful for you, especially during tax time.
They protect you against fraud
The built-in fraud protection of your credit card gives you peace of mind in cases where your cards get stolen. Card companies act fast once you’ve reported the theft to them that you will hardly lose any cash on fraudulent purchases made on your card.
They have a grace period
When you make a purchase or cash advance and were able to pay it off in 30 days or less, you just literally used other peoples’ money for free.
They are universally accepted
You can walk into any major establishment anywhere in the globe and confidently purchase without being rejected. Some establishments even determine the number of privileges or extra perks to offer you by the type of card you carry.
Will Paying Off My Credit Cards Improve My Score?
The main reason why you’re highly likely to improve your credit score upon paying off your credit card debt is that it will bring down your credit utilization ratio. Second, to payment history, credit utilization ratio is one of the most influential factors affecting your credit score.
Credit utilization indicates how much of your available credit you are currently using. If your total line of credit is $8,000m and you have an outstanding balance of $4,000, you might think that’s a good ratio. This 50% utilization ratio will definitely hurt your score. By paying off a big chunk of your debt, you will now have a significantly lower ratio.
Of course, apart from the improvement in your score, you would also benefit from tons of dollars saved from interest charges and other potential fees when you begin missing payments, or worse, default on your account.
Why Your Credit Score May Experience a Drop When You Finally Pay Off Your Credit Card Debts
It may be strange to think why paying off your credit card debts can also cause some setbacks. But know that even when your score takes a hit, it is only temporary.
Several credit score calculation factors also get affected when you pay off your credit card debts.
Credit Utilization Ratio (30% of credit score)
Credit bureaus will not take it as good news when you have brought down your credit utilization ratio to less than 10%. You appear as a high credit risk because no credit utilization is just as bad as high credit utilization.
Length of Credit History (15% of credit score)
Paying off your credit cards shortens the period where credit bureaus use your submitted credit reports to analyze your credit management. Upon pay off and you decide to close your account, all credit history of that account will no longer be included in your record.
Credit Mix (10% of credit score)
There is no one-size-fits-all credit management because credit experiences vary with each type of credit account. The more variety of credit types you have in your portfolio, the more you can demonstrate sound credit management.
New Credit (10% of credit score)
Because your credit card debts are finally out of the way, you will likely make hard inquiries or apply for a new type of loan. Hard inquiries will cause hard pulls on your credit report, affecting your score almost immediately.
How to Be a Responsible Credit Card User
You might find it quite overwhelming to manage credit cards when avoiding the temptation of using an open line of credit becomes a bit of a struggle. An approach that you might want to consider instead of paying off your credit card debt is to manage your account responsibly. By doing so you’ll avoid debt accumulation that affects most credit card users.
Here are the experts’ advice in managing your credit cards properly.
- Build a safety net that is equivalent to at least 3 to 6 months worth of your living expenses.
- Live within your means. Don’t increase your lifestyle spending, even if you have raised your income or salary.
- Limit your number of credit cards. Select the best three credit cards that you can find, each providing different features that are important to you.
- Know your credit card terms. The more you know, the more you avoid credit mismanagement.
- Pay your full balance each month, or more than your minimum amount due.
- Always pay on time.
- Avoid cash advances on your credit card because higher APR is applied to them than regular purchases.
- Avoid unnecessary balance transfers.
The benefits of having a credit card cannot be underestimated. If you manage them well, they are your best tool in building successful credit and accessing financial opportunities in times when you least expect them.