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When you’re working on building up your credit and improving your credit score one of the best things you can do is use a credit card. But if you’re not careful, that credit card can do more harm than good if you use it too much and don’t pay it off.
What’s important to note is that your use of credit cards is a big factor on your credit score because other financial institutions and lenders look at it as an example of how you’re going to manage debt. Making your payments on time, as a result, greatly impacts your credit score, by up to 35% when it comes to FICO.
Of course, using the right amount of credit is another important factor. For a financial institution or lender this is looked at as how much credit you’re using compared to how much credit you have available and the result is the credit utilization rate.
Using Your Credit Card to Improve Your Score
Make the Payments On Schedule
The most important thing that you can do is pay your bills on time, because it’s going to make a big impact on your credit history and score. In fact, it counts for 35% of your credit score. What’s really important to note, however, is that your record lasts longer than even the last six months (though you can see improvements in that time).
If you can make a habit of paying on time you’re going to establish a great record for your credit score.
While you may think that moving a high balance to a different card would be good, this actually causes an inquiry that can drop your credit score. In general, if you get a new credit card you’re going to get a little bit of a credit increase, however, which means that transferring that balance likely won’t hit you too hard.
The important thing is to make sure you keep old cards and accounts open, even if you transfer the balances, because if you do this and you don’t increase your debt you’ll actually end up with a lower credit utilization rate. Having that lower rate means you’re going to have an increase in your score.
Keep in mind, that utilization rate or balance-to-limit ratio is important. It’s a way of looking at the amount of credit you’re using compared to the amount that you have available. To create your credit score, your report evaluates individual card utilization as well as overall card utilization. If you have a lower rate over all of these areas you’re going to be considered a better risk and that can help improve your score.
If you’re looking to figure out your own credit card utilization rate just add up the total balance on all of your cards and then the total amount available on all of your cards. Divide the amount used by what’s available.
Keep it Diversified
You’ve probably heard about diversity being good but you might not have known that it applies to your credit. A mix of credit types that are being paid off properly makes you look like a better risk and a more responsible person. When you apply for new types of credit you show that you’re good at balancing different types of debt and that you can process and utilize them properly.
For those who have only had certain types of loans or debts if you open a credit card compared to only having loans you may actually see an increase in your score because of the new mix of credit.
Keep it Secured
Sometimes it can be difficult to get a credit card if you have bad or no credit. That’s when a secured card may be just what you need.
With a secured card you’re actually putting money into a specific account that will cover the credit line. So, if you want a credit card with a limit of $200 you would have to deposit $200 into an account first. You would then need to supply the information about that account to whoever issued you the card so that if you don’t pay, they can take the money. You may even be able to get interest on these deposits, depending on how they’re stored.
Now, if you don’t make the payment the institution that gave you the card can pull the money out of the account. It’s considered a safety measure for the bank because someone with bad credit may decide not to make the payment.
For those who don’t qualify for a regular card, this can be the key that you need to get started on building up your credit to get one later on. There are many different cards for this purpose such as Capital One Secured Mastercard, Discover It Secured and more.
Your Credit Card Could Be Hurting Your Score
Getting New Credit
When it comes to applying for any type of financing, including loans and credit cards, you’re going to get a hit on your credit report, even if you don’t get approved.
Applying for any type of credit allows a lender (or potential lender) to run a credit report and look at whatever information they want to decide if they want to approve you and what they’re going to offer in terms of a credit limit or interest rate. Your credit report lets them know your current history for payments and even the balances on your current cards.
The process of getting access to your credit report requires that an inquiry be made, which is how it shows up on your credit report. But you need to know a little more about the types of inquires that are made.
- Hard Inquiry – This type of inquiry is the one that you get when you are applying for some type of credit and it’s the one you get from financial institutions. You have to give permission for this type of inquiry (which may be in the form of an application or a check box) and they make an impact on your score. They’re also going to be visible on your credit report.
- Soft Inquiry – This type of inquiry happens when an employer or even you check your score. These inquiries aren’t visible to anyone else that checks your score and they also won’t hurt your score in any way.
When it comes to how these types of inquiries are going to affect you it actually depends on what your current situation is for your credit score. For most people, a credit inquiry will have a very minor effect on a FICO score. They generally change your score by only 5 points or less where your range is actually a 300 – 850. That’s not very much. But if you don’t have a lot of credit history that 5 points could make a big impact.
If you have a lot of inquiries also it can make a big impact because creditors think of you as a bigger risk. In fact, FICO has found that people who have more than 6 inquiries showing on their credit report are actually far more likely to declare bankruptcy than someone who doesn’t have inquiries. Still, don’t obsess over this area to the exclusion of others.
Paying Bills Late
If you make a payment on your credit card late even once it can negatively affect your credit score. That’s because your FICO score uses payment history for 35% of your score and for your Vantage Score, which is used by other institutions, it’s counts very high.
For those who don’t make on time payments or who don’t make payments it causes a huge decrease in your credit score. On the other hand, you can do quite well if you make all your payments on time. Just keep in mind that your late payments may not be reported if they’re less than 30 days.
Closing Your Accounts
Some people think that closing out an account once they’ve paid it off is a good idea, but that’s not always the case. Sometimes it pays to keep that account open. That’s because closing an account is going to increase your credit utilization rate and lower the amount of available credit that you have, thus lowing your credit score.
So how does it go?
Well, let’s take a look at things. If you are currently using $1,000 of a $6,000 available credit line you’re actually using about 16%. If you closed a credit card and you had only $2,000 available and were still using that $1,000 you would be at 50%. That’s a big difference and for your credit score it can be a huge impact. Because you closed that card you actually increased your utilization.
Maxing Out Your Cards
One of the biggest problems that you can run into is maxing out cards. First, you’re going to have a hard time paying off a balance that’s so big. You’re also going to have a hard time taking care of emergencies if you need that card to pay for one.
Next, you’re going to have a higher utilization rate on your credit report. And that’s going to decrease your score. If you have anything over a 30% utilization rate, in fact, you’re going to be considered a risk. Maxing out your credit cards is definitely going to put you over that limit.