Your credit card is, without a doubt, going to affect your credit score. To understand how the two are correlated, it is important to recognize that your credit score is comprised of data that relates to how you use and manage debt. Why does your credit score matter? Any time you seek approval for housing or a loan, your credit is assessed as a representation of your financial reliability. One of the easiest ways to build your credit profile and improve your score is through the strategic use of credit cards as credit-building tools.
Chicago-based project manager Christina Lewis wants to utilize her credit cards and pay off her student loan debt to achieve her financial goals. Tonya Rapley, founder of My Fab Finance, helps Lewis discover what it takes to build a strong credit score and manage her debt toward a solid financial future.
What impacts your credit score
How you use your credit
Otherwise known as “utilization,” creditors like you to use credit but not overuse it. To keep your credit in good standing, try to use no more than 30% of your total credit line. This means that if you have a credit card limit of $10,000, keep your running balance below $3,000 — if you’re going to carry a balance at all.
Your payment history
This is where paying your bills on time every time comes in handy, even if it’s just the minimum payment. Once payments are over 30 days overdue, they can be reported to the credit bureaus and may significantly decrease your credit score. If remembering to pay your monthly bill on time is a concern, set up automatic payments from your bank account to ensure payments are on time.
An inquiry is when a potential or existing creditor accesses your credit report to determine if you meet their lending requirements for the loan or line of credit for which you are applying. A hard inquiry affects your credit score for one year and remains on your report for two years. Keep this in mind when asked to cosign for someone else’s loan, as a cosigned loan is considered yours and will show up on both your credit histories. If the other person is unable to pay, it can negatively impact your score.
The type of credit you have
Also referred to as your “credit mix,” having diverse forms of credit such as revolving (credit cards) and installment debt (student loans, mortgage and auto loans) help your credit score and profile. Potential lenders like to see that you can manage various types of credit responsibly.
Age of your accounts
The older your accounts, the better. Older accounts in good standing demonstrate a consistent ability to manage your debts. Closing accounts can have a negative impact on your credit score, so instead of canceling an account, stop utilizing the card regularly in favor of occasional use for small purchases to help avoid account closure and keep improving credit.
When considering which card to use
Fees can be costly. Common charges such as annual fees can range anywhere from $25 to $500. Not every card has an annual fee, so look for a card without one. Other costs to watch out for include transactional fees — for actions such as balance transfers and cash advances — and penalty fees, like overlimit charges or late payments.
While your interest rate depends on your credit, some card companies offer low introductory rates. Typical interest rates range from 11%-30%, and introductory deals are usually 0% for a specific time period such as six or 12 months. The lower the rate, the less money the card will cost you. Also pay attention to how the interest rate is calculated.
Perks or rewards
There is no shortage of credit card options. Most companies offer incentives that can range from cash back to airline miles. Compare your card options and if you are interested in a rewards card, choose one that easily benefits your lifestyle.
Using a card to improve your score
Pay your bill on time
Once you get a credit card, focus on maintaining a perfect payment history. Missing a single payment can reduce your credit score by 40 points or more! Think you’re going to be late or miss your payment entirely? Contact your credit card company immediately to determine your options.
Keep your balances low
You will need to use your card to benefit your credit (and to ensure the card servicer does not close the account). The ideal balance you should carry on a card is 30% of your credit limit or less. Keep in mind that credit scoring models don’t penalize you for maintaining a low balance. Even a small monthly charge, like a $14.99 gym membership, is enough to help improve your credit so long as you pay your balance in full every month.
Keep your wallet thin
All you need is one card to do the trick. The more cards you apply for, the more hard inquiries you’ll receive, which could negatively impact your credit score. In some cases, spreading your spending among two or more cards can be beneficial. If you’re regularly using over 30% of your card’s available credit, for example, you might consider opening a second to decrease your overall utilization. There can also be additional benefits to utilizing more than one card.
Make sure you’re connected
To affect your credit score, your payment history needs to be reported to the credit bureaus. Servicers are not legally required to report your accounts to the bureaus. It’s voluntary, which is why it’s possible for an account to appear on your Equifax credit report but not your TransUnion report. For a card to boost your credit, the servicers needs to report both the trade line and your activity.
When used responsibly, credit cards can be helpful and relatively simple tools to build (or rebuild) your credit portfolio. Discipline is critical with this strategy, and it’s important to remember the purpose of your cards. They should be used to build credit, not as a means to live beyond your means and create debt.