Is It Bad to Pay Your Credit Card Early?
Is It Bad to Pay Your Credit Card Early?
No. It’s not bad to pay your credit card early, and there are many benefits to doing so. Unlike some types of loans and mortgages that come with prepayment penalties, credit cards welcome your money any time you want to send it.
Benefits of Paying Early
Some credit should be paid early, and some credit should not, so it’s important to understand the difference. There are two types of credit you can be offered: installment credit and revolving credit.
Installment credit: This includes car loans, student loans and mortgages, where you’re approved for one lump sum up front and pay it back over time.
Installment loans typically come with a term (such as a 5-year car loan or a 30-year mortgage), a rate of interest that you pay for the privilege of borrowing the money, and a set amount that you’re expected to pay each month over the term of the loan.
But paying early on installment credit is not always in your best interest (pun intended). In fact, installment loans may come with a prepayment penalty because the lender wants you to keep paying them for the length of the term. Lenders usually offer low interest rates to make this scenario manageable and attractive.
Revolving credit: Revolving credit includes credit cards and lines of credit where you’re allotted a certain amount, and can use whatever is available at that point in time. Unlike installment credit, there is an added benefit to paying revolving credit early. By reducing your account balance, you effectively save money on the interest due.
As an example, if you have a credit card with a $500 credit line, and you spend $100, you have $400 left. If you pay that $100 right away—or at least within the grace period—you’re back at $500 in credit and would owe no interest.
Beyond avoiding interest charges, paying early and reducing your credit balance can also have a positive impact on your credit score.
Impact on Credit Score
Many financial advisors recommend only charging what you can afford to pay off each and every month, so you’re never carrying a balance or racking up interest charges.
But more than just paying in full before the due date, regularly paying off your credit card early (like several weeks before the due date) usually results in an increase in your credit score.
The last day of your billing cycle is called the “statement closing date,” which is usually at least three weeks (21 to 24 days) before your due date. This is the day interest and minimum payments are calculated, and the outstanding balance is reported to credit bureaus. So if you make your payment before that date, all those numbers go down and you get a better report.
Reduce Credit Utilization
The other way an early payment positively affects your credit score is by lowering your credit utilization ratio (CUR). This number is the amount of credit you have that you’re actually using, and your credit score goes up when you keep your CUR below 30%.
You can calculate your CUR at any time by dividing your total debt, or balance, by your total credit limits. Only revolving credit takes your credit utilization ratio into account. Installment credit is based on your debt-to-income ratio (DTI) instead.
Reduce Interest Charges
Because interest charges are calculated on your closing date rather than your due date, if you pay off your credit card early (before your closing date), you can reduce the interest charges on your account.
Of course, this depends on the card issuer. Most calculate your fees on an average daily balance rather than the monthly amount, so you’ll still end up paying interest. However, the earlier you pay your bill, the less that average daily balance will be.
For example, if you have a $500 balance at the end of the previous cycle, and you pay it off 10 days into the new period, the next interest fee will be based on an average daily balance of $150/day.
That’s because you had a balance of $500 on the first nine days, which adds up to $4,500. And zero for the rest of the month in the 30-day billing cycle. So $4,500/30 is $150.
On the other hand, if you pay it off just four days into the new period, interest will be based on only $50/day. $500 x 3 days is $1,500, divided by 30 is $50.
Avoid Late Fees
On top of interest charges, your credit card company probably charges a late fee for missing your payment date. That can be as much as $41, depending how many times you’ve missed your due date.
If you’re paying your credit card bill off early, you’re not going to incur these late fees. However, if you pay it off too early, it won’t count towards the next month. So if you still have a balance on your card, you still have to make that payment date with at least the minimum amount.
What Is Best for You?
Obviously paying off your credit cards requires having the money to do so. And chances are you have a credit card specifically because you don’t have enough cash on hand (or in the bank) to cover every purchase.
The trade-off with credit is you’re paying over time (the interest rate, account fees, etc.) to receive money up front. However, it’s always nice to pay less. And by paying your credit card early, you end up paying less. The question is, do you have enough capital on hand to do that?
Only you can decide whether it’s better for you to pay off your credit card as soon as possible, enjoying the benefits that come with it … or to keep a balance on your card so you have enough cashflow in your bank account.