Laura reviews six ways to use credit cards to build excellent credit scores that will improve many areas of your financial life.
Laura reviews six ways to use credit cards to build excellent credit scores that will improve many areas of your financial life.
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Building great credit is part of a healthy financial life. The higher your credit scores, the more you can save on various products and services, including credit cards, lines of credit, car loans, and mortgages.
But you may not realize that your credit affects many aspects of your finances. For instance, having poor credit may cause you to pay more for auto, homeowners, and renters insurance (in most states).
Low credit scores could also cause you to be turned down by a prospective landlord or employer and increase the security deposits you must pay on utilities such as power, cable, and mobile devices.
Using a credit card responsibly is one of the best ways to build a positive credit history and boost your credit scores. They typically report your card activity to one or more national credit bureaus, Equifax, Experian, and TransUnion, which enter it on your credit reports.
This post will review six ways to use credit cards to gain benefits and build excellent credit.
Hey friends, welcome back! I'm Laura Adams, an award-winning author, money speaker, founder of The Money Stack newsletter, and host of the Money Girl podcast with 43 million downloads. I also work as an on-camera financial spokesperson and partner with select brands for PR and content marketing. As always, you can learn more and email me at LauraDAdams.com.
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6 Ways Using Credit Cards Can Build Excellent Credit
Whether a credit card helps or hurts your credit depends on how you use it. Here are six ways to use cards to boost your credit and the benefits that come with maintaining great credit scores.
1. Make payments on time.
Making timely payments on all your bills and credit accounts, including credit cards, is critical for building great credit. Your payment history indicates your financial responsibility and ability to pay what you owe.
Some of your payments, like rent or a cell phone bill, may not be reported to the nationwide credit bureaus. However, if you don't pay those accounts and they are turned over to a collections agency, that will appear on your credit reports.
Your payment history is the most significant factor in many credit scoring models. It makes up 35% of your FICO score, which most top lenders use.
Having a credit card allows you to demonstrate your creditworthiness by making payments on time. However, late payments on credit accounts show potential lenders and merchants that you may not be responsible and could default on your debts.
If a card company receives your payment, even the monthly minimum, by the statement due date, you build a positive history on your credit reports. However, I recommend paying more than your card's minimum.
Ideally, you should pay off your entire balance monthly to avoid accruing interest charges. If you carry a balance from month to month, use a low-interest credit card to reduce the financing charge.
READ ALSO: 6 ways to get more value from your credit cards
2. Don't rely on being an authorized user.
Many people start using a credit card by becoming an authorized user on someone else's account, such as a parent's. That allows you to use their card without being legally responsible for the debt.
Some card companies report a card owner's transactions to an authorized user's credit report. That could be an excellent first step for establishing credit--if the card owner makes timely payments. Even so, some credit scoring models ignore data that doesn't belong to a primary card owner.
Therefore, don't assume that being an authorized user is a rock-solid approach to building credit. It's best to get your own credit card as soon as you earn an income and can get approved.
If you can't get approved for a credit card, a secured credit card that reports data to the credit bureaus is an excellent tool to build or rebuild your credit. They work like a regular card but require you to pay a refundable security deposit when you open the account. After a period of responsible use, you'll qualify for a regular unsecured card.
3. Don't max out credit cards.
A significant credit scoring factor is the amount of debt you owe on revolving accounts (such as credit cards and lines of credit) compared to your total available credit limits, known as your credit utilization ratio. It is calculated per account and on your accounts' aggregate total.
A low utilization ratio shows that you use credit responsibly by not maxing out accounts. A high ratio indicates that you use a lot of credit and could even be in danger of missing a payment soon. A good rule of thumb to build your credit scores is to keep your utilization ratio below 20%.
For example, if you have a $1,000 card balance and a $5,000 credit limit, you have a 20% credit utilization ratio. The formula is $1,000 balance / $5,000 credit limit = 0.2 = 20%.
There's a common misconception that maxing out a card is OK if you pay it off each month. While paying off your card is best to avoid interest charges, it doesn't guarantee a low utilization ratio.
The date your credit card balance gets reported to the credit bureaus may differ from your statement due date. If your outstanding balance happens to be high when it gets reported, you'll have a high utilization ratio that drags down your credit scores.
READ ALSO: Know your score and improve your credit
4. Consider owning multiple credit cards.
Another way to reduce your credit utilization ratio is to increase the amount of your available credit. For instance, you could request a credit limit increase with your credit card issuer.
Or, you can apply for an additional credit card and spread out your charges on multiple cards instead of regularly maxing out one. Having another card increases your total available credit, reduces your credit utilization, and boosts your credit scores.
For example, instead of having one card with a $1,000 balance and a $5,000 credit limit, suppose you get a second card with a $5,000 limit. If you have a $500 balance on each card, you'd have a 10% credit utilization ratio instead of 20%.
The formula is $1,000 balance / $10,000 credit limit = 0.1 = 10%. That's half the ratio of my previous example for one card because you have twice the amount of available credit with two cards.
Remember that having the same amount of debt with more available credit instantly reduces your utilization and improves your credit scores.
5. Don't cancel credit cards.
When you cancel a credit card, you instantly slash your available credit. That causes your credit utilization ratio to skyrocket, and your credit scores drop quickly.
Anytime your card balances become a higher percentage of your total available credit, you appear riskier to creditors, even if you aren't. So, keep your cards open and active, especially if you're considering a big purchase, such as financing a car or applying for a mortgage in the next six months.
However, if you have a card that you don't like, don't be afraid to cancel it. Just replace it with another card, ideally before you cancel the first one. That allows you to swap out one credit limit for another and avoid a significant increase in your credit utilization ratio.
RELATED: What to know before you cancel a credit card
6. Wait to open new accounts.
Another credit scoring factor is your recent "hard inquiries," which happen when you apply for new credit, such as a credit card or loan. They temporarily ding your credit scores.
So, once you apply for a credit card or loan, wait at least six months before applying for another credit account. Spacing out new accounts or cancelations ensures they have the most negligible impact on your credit as possible.
If you're wondering about the ideal number of credit cards you should own, it depends on how much you charge, whether you use card rewards, and how responsible you are with credit.
As I mentioned, having more available credit helps your credit. Therefore, if you continually use over 20% of your available credit, you likely need an additional card.
Also, consider how different credit cards help you achieve financial goals, such as saving money on everyday purchases. Many retailers, big box stores, and brands have rewards credit cards that offer discounts, promotions, and additional services.
Owning at least two credit cards, or as many as you're comfortable managing, will benefit your finances. If you handle them responsibly, there's no limit to the number of cards you can or should have.
You can check your credit for free at sites like Credit Karma and Credit Sesame without hurting your scores because it's a “soft inquiry” on your credit reports. It's wise to check your reports at least annually for activity you don't recognize, which could be a sign of identity theft that you should dispute right away.
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