How Having a Zero Balance Affects Your Credit Score
Paying your credit card down to a zero balance each month can help you build credit and improve your score. However, keeping your card at zero because you never use it can prompt the issuer to close your account, which may actually hurt your score.
What does having a zero balance card mean?
Having a zero balance credit card can mean two different things: paying your card off in full each month or keeping your balance at zero due to inactivity. While the former is an excellent credit-building strategy, the latter can make your score drop if your credit card company closes your account.
As long as you're using your credit card on a regular basis, having a zero balance shouldn't hurt your credit score. On the contrary, paying off your bill each month can help your credit utilization, which in turn boosts your score.
Credit utilization is the ratio between your total available credit and how much debt you carry. As a general rule, you should try to keep this ratio below 30 percent.
Your credit utilization makes up 30 percent of your credit score. After your payment history, it's the most important of the five factors that determine your score.
This is why it's a bad idea to carry a sizable balance from month to month. In addition to racking up interest, you decrease your available credit, which raises your credit utilization rate.
Some credit card users think you should never carry a balance under any circumstances if you want to break into the 800+ credit score range. However, financial experts explain that credit scoring models actually rank a 1% credit utilization rate higher than 0% because it shows the consumer is using credit rather than letting their cards sit inactive.
Furthermore, experts say people with credit scores in the top 25% use around 7% of their credit limit on average. The takeaway is that it's less important to focus on maintaining a zero balance and more important to focus on paying your bill on time every time.
Example of a zero balance card
Just because you pay off your credit card in full each month doesn't mean your credit report will show a zero balance when your card issuer reports to the credit bureaus. This is because credit card companies do their reporting at different points during the billing cycle, which usually runs between 28 and 31 days, give or take, depending on the issuer.
For example, if you use your card to make a $200 purchase on the tenth day of the month and pay off the full balance on the fifteenth day but your card issuer doesn't report to the credit bureaus until the seventeenth day, your credit report will show that you paid your bill on time but it won't reflect a zero balance.
Does having a zero balance affect credit score?
Having a zero balance can affect your credit score in a positive way if you use your card regularly and then pay it off. However, a zero balance due to inactivity can potentially hurt your score if your card issuer ends up canceling your account.
People are sometimes surprised to find out that credit card companies close accounts after a period of inactivity. While some card issuers warn account holders before they do this, others will cancel an account with no notice.
Credit card companies make money on cards by charging interest and collecting fees from merchants that accept credit. When you stop using your card, they don't make any money on your account and might decide to close it as a result.
While federal law prohibits credit card companies from charging inactivity fees, there are no rules stopping them from canceling dormant accounts. When a card issuer cancels your account due to inactivity, this can hurt your credit score in a couple of ways.
First, having your card canceled can deprive you of credit history, which makes up 15 percent of your credit score. If you had your card for a long time, this can cause your credit score to take a dive.
Also, you lose available credit when a card issuer cancels your account. This can make your credit utilization ratio increase, which can hurt your score.
Pros vs. cons of zero balance credit card
There aren't any real downsides to having a zero balance credit card that you use and then pay off each month. The problem is having a card with a zero balance all the time because you never use it.
When your balance is $0 month after month due to inactivity, most credit card companies will stop reporting your card activity to the credit bureaus. When this happens, your credit report doesn't show any recent history for that card, which can make it hard for potential lenders to determine if you're a responsible user of credit.
Now assume you pay off multiple credit cards and then throw them in a drawer where they sit for a year with a zero balance. Eventually, the card issuers will cease reporting to the credit bureaus because you don't have any new activity.
This scenario can damage your credit score. When you never use credit, you make it impossible for future creditors to assess what kind of borrower you are.
The better course of action is to use your credit cards periodically. You don't have to make big purchases to keep your cards active.
Instead, make modest charges and then pay them off each month. This ensures your card issuer continues reporting your account activity, so you get credit for your positive payment history.
Zero balance FAQs
The following are some of the most common questions and answers regarding having a zero balance credit card.
Is it better to pay off your credit card or keep a balance?
To get the most out of your credit cards, it's best to make at least small purchases from time to time and then pay them off every month. This prevents your cards from going inactive, which might prompt your credit card company to close your account.
Remember that there's nothing wrong with having a zero balance as long as you use your card enough to keep your account active. However, going long stretches of time with a zero balance due to inactivity can lead to your card issuer canceling your account, which can hurt your credit score.
Why did my credit score drop when I paid off my credit card?
In some cases, your credit score might go down when you pay off a credit card. Fortunately, it will probably only dip a few points and the decrease will be temporary.
According to finance experts, paying off any kind of debt — a car loan, student loan, or credit card — can affect the algorithm used by credit scoring models to calculate your credit utilization ratio.
However, it doesn't take long for the algorithm to correct itself, and your credit score should quickly bounce back.
Your credit score might also decrease if you close your credit card accounts as you pay them off. This shortens your credit history and shrinks your available credit, which can lower your score.
To avoid any damage to your credit score, keep your credit cards open after you pay them off. You should also make sure they stay active by making small purchases every now and then and immediately paying them off.
What happens when your credit card balance is zero?
What happens when your credit card balance is zero depends on how long it stays that way. If your balance is zero because you never use your credit card, there is a good chance your credit card issuer will eventually close your account.
If this happens, your credit score could suffer. An easy fix is to use your card at least once every three months, making small purchases and then paying them off if you want to keep your account paid off.
If, on the other hand, your balance is zero because you use your card and pay it off each month, this is good for your credit score. Doing this helps you build positive payment history while keeping your credit utilization rate low.
Does closing a zero balance credit card affect your credit score?
Yes, closing a zero balance credit card could hurt your credit score. This is because shutting down your account can deprive you of valuable credit history and decrease your available credit — both of which can lower your score.
Generally, you should avoid closing a credit card. One exception is when a card has a high annual fee or monthly maintenance fees that are costing you money.
A zero balance credit card can be a credit-booster if you use it regularly and pay it off, but an inactive card with a zero balance can hurt you. To get the most credit-building benefits from your credit cards, only charge what you can afford and then pay your balance in full each month.
About the Author
Mike is a recognized credit expert and founder of Credit Takeoff. His credit advice has been featured in CNBC, Investopedia, CreditCards.com, Bankrate, Huffpost, The Simple Dollar, Reader's Digest, LendingTree, and Quickbooks. Read more.