Editorial Policy

Should I Pay Off my Card Debt Gradually?

Eva Norlyk Smith Ph.D.

March 18, 2013

QHi Eva,

I have just under $2,000 in debt on a credit card with 19.99 percent interest, and a $7,000 credit limit. I've heard that, with some kinds of loans, it's better to pay them off gradually because then it helps you have better credit for a longer time — student loans, for example. But is that true with credit cards? I got a second job recently, and I can probably pay $1,000 a month and get rid of all the debt. Or should I draw it out a bit longer? I no longer make purchases on the card. The debt is from an emergency this past December, and I don't plan to charge on it once the debt is paid off unless there is another emergency. — Courtney

ADear Courtney,

You may have heard the advice that paying off low-interest student loans early is a bad idea. However, that particular advice is tied to the notion that you should take advantage of the low interest rate and invest the extra money or build up an emergency savings account. Your credit card debt, however, is costing you 19.99 percent per year — so I say, if you can, pay it off!Ask Eva

In fact, the assumption that it's better for your credit to pay off any kind of debt slowly is not correct. Many people run the risk of hurting their credit by carrying long-term credit card debt if the balances get too high. Credit card balances that use up more than 30 percent of a credit limit damages credit scores by affecting the debt-to-credit ratio. Also known as credit utilization, this is a measure of how much of the available credit a person uses, and this ratio accounts for a full 30 percent of your FICO score.

In your case, because your credit card balance is 28.5 percent of the credit limit (or $2,000 divided by $7,000), it's not a huge concern. But even so, your credit score would be better if that ratio was much, much lower — ideally around 10 percent to 20 percent of your credit limit.

Now, there is a kernel of truth to your assumption, and that is that you have to use credit to build credit. However, that doesn't mean holding on to debt and paying it down gradually. It simply means having active credit accounts. To do that, you're going to have to ditch your plan of using that card only for rare emergencies. You should use it more regularly. In fact, while you're worried that paying off your debt too soon will ding your credit, putting your card in a drawer and forgetting about it will do far more damage.

Card issuers report the balances on credit cards monthly to the credit rating agencies. Those balances, along with the bill payments, become part of your credit history and help build your credit scores. Credit reports create a profile of each person's credit management habits. So regular monthly payments, as well as a long-term pattern of using credit responsibly by keeping card balances low, will help build a great credit score.

The best part is that you don't have to carry any debt at all to build your credit.

The key to having perfect credit without paying a dime in interest is to use the credit card regularly, but pay the balance off in full before the due date each month. If you want to increase your credit score even more, consider getting (at least) one more credit card and using that regularly as well, paying the bill in full each month.

Yes, it can be a pain in the neck to have to use several credit cards just to build up your credit. But since you are concerned your credit score, there's no way around it. Like it or not, credit card activity accounts for a major part of the credit information compiled on credit reports, and you unnecessarily disadvantage yourself by not using credit cards actively.

There are ways to minimize the inconvenience of having to use those credit cards regularly, however. Just charge something to your cards every two to three months to keep some activity on the accounts.  Or, charge regular bills to the cards and set up automatic monthly payments from a bank account so you can just set it and forget it.

It takes time, patience and attention to build a good credit score. But when it's time for you to apply for a car loan or mortgage, and you find yourself courted by lenders offering you the lowest interest rates available, you'll be really glad you had the smarts to get that top score.

Got a question for Eva? Send her an email.