Building a solid credit history and maintaining a high score can often feel like a complicated endeavor.
While certain positive financial habits are obvious, like making on-time payments; other moves that can hurt your score aren’t quite so clear cut.
Understanding the factors that go into determining your credit score and how different types of financial accounts are treated, can help keep your credit health in check for when you need it most.
Debit cards, for instance, don’t carry the same credit implications as credit cards. But what about charge cards?
Closing a Charge Card
Many advise against closing credit card accounts -- for good reason. Once a credit card is closed, you have less credit available to you.
If you carry a balance on other credit cards, this will lead to an increase in your credit utilization ratio. Why? Your available credit dropped, but the amount charged stayed the same.
Since charge cards don’t have an impact on your credit utilization ratio, closing them doesn’t have this credit score impact. However, it does have an impact on your length of credit history.
For instance, if you’ve had a charge card for nine years, and three credit cards open for 5, 4, and 2 years, your average length of credit history would be five years.
If you close the charge card, your average length of credit would drop to approximately 3.7 years. On the other hand, if the charge card isn’t one of your longest held cards, this could have little to no impact on your score.
Some credit scoring models will continue to take into consideration the age of closed accounts, as long as they are still on your report.
Other credit scoring models will exclude the age of an account if it’s closed.
The bottom line? It depends on the entirety of your credit picture and when you first established the charge card account.
What Are Charge Cards?
Say the words “charge card,” and many people simply assume you’re talking about a credit card. But the terms aren’t exactly interchangeable.
Charge cards are a type of card, but they don’t work the same as traditional credit cards.
What Makes Them Different?
That’s right. Charge cards don’t charge interest. But that’s because they require your card balance to be paid in full each billing cycle. So essentially there’s nothing to charge interest on because you can’t carry a balance.
While credit cards have strict credit limits, charge card spending limits are a bit more fluid.
American Express charge cards, for instance, offer no “pre-set spending limits.” Instead, they look at your annual income, credit history, and regular spending on the card (and all other accounts held with them), and determine what’s “reasonable.”
If you exceed that in a given month, they could prevent you from making more purchases. However, if you plan on making a large purchase, you can ask for an exception.
Shorter Grace Periods
Credit cards will charge fees for late payments but, unless you are months behind or your card is maxed out, you can usually still make new purchases.
Charge cards aren’t usually so lenient. Spending privileges could be cut immediately if you miss any payments.
There’s a good reason many people aren’t familiar with the term “charge card” -- there aren’t nearly as many charge cards to choose from as there are credit cards.
The main issuer of charge cards is American Express, while there are dozens of providers to choose from if you prefer a credit card.
What Makes Them Similar
Just like many credit cards, charge cards come with an annual fee. This is because charge cards offer the same protections and sometimes similar perks as credit cards.
Protection Against Fraud
Perhaps the biggest reason charge cards are more in line with credit cards than debit cards is that they offer the same protection against fraud. In other words, consumers usually have zero liability when it comes to fraudulent charges.
Charge cards also offer another perk that often makes credit cards more attractive than debit cards: rewards programs. American Express charge cards, for instance, allow charge card users to cash in on the same rewards as credit card users.
Many people opt for credit cards over debit cards because of the help they offer in building credit. But do charge cards offer similar benefits? And what are the negative implications if a charge card isn’t paid on time, or if it goes into default?
Let’s first take a look at how credit works.
All About Credit Scores
While there are several different credit scoring models, the most widely used is FICO.
The exact way in which scores are calculated using this model is relatively complicated, but we do know that it takes into account five different factors, each carrying a different level of importance.
Payment History (35% of total score)
The largest portion of your credit score looks at how well you’ve done at paying each of your creditors on time.
If you do have late payments, it takes into account how many and how late they actually were. Several payments over 90 days late obviously carry more weight than one payment less than 30 days late.
Amounts Owed (30% of total score)
The next part of your score with almost equal consideration is the amount you owe to each of your creditors.
This looks at both installment loans (like student loans and automobile loans) and revolving credit (like credit cards and lines of credit).
For revolving credit, this also means looking at your credit utilization ratio -- how much you have used versus how much is available to you. A high credit utilization ratio could spell trouble for potential lenders or creditors.
Length of Credit History (15% of total score)
If your payment history is stellar and you’ve managed to keep the amounts you owe to creditors to a minimum, the next credit risk indicator is how long you’ve been using credit.
The longer your history, the more reliable you look. This takes into consideration the age of your oldest and newest credit account, an average of all accounts, the age of specific accounts, and how long it has been since you’ve used your accounts.
Credit Mix (10% of total score)
Do you have several credit cards but no installment loans (i.e. car loans, mortgages or student loans)?
Even if you have used credit responsibly, not having a mix of types suggests you aren’t well-rounded in your use of credit. This, in turn, could lead to a lower score.
New Credit (10% of total score)
This portion of your score takes a look at recent behavior. Have you opened up several credit cards or lines of credit recently?
That could indicate you have come into some financial trouble and need the extra cash flow -- a red flag to potential lenders or creditors.
Credit Score Ranges and Quality
|Credit Score Ranges||Credit Quality||Effect on Ability to Obtain Loans|
|300-559||Very Bad||Extremely difficult to obtain traditional loans and line of credit. Advised to use secured credit cards and loans to help rebuild credit.|
|560-649||Bad||May be able to qualify for some loans and lines of credit, but the interest rates are likely to be high.|
|650-699||Average/Fair||Eligible for many traditional loans, but the interest rates and terms may not be the best.|
|700-749||Good||Valuable benefits come in the form of loans and lines of credit with comprehensive perks and low interest rates.|
|750-850||Excellent||Qualify easily for most loans and lines of credit with low interest rates and favorable terms.|
How Do Charge Cards Affect Your Score?
Since your credit score takes into consideration each of the accounts that make up your full financial picture, charge cards can also have an impact. Although not quite in the same way as credit cards.
One of the biggest ways a charge card can have an impact on your overall credit score is when it comes to your payment history.
Making on-time payments every month will help show that you are responsible in your use of credit. On the flip side, making late payments -- even just once -- can put a black mark on your report that only time can erase.
This is where credit cards and charge cards differ. Because credit cards have a credit limit, it’s easy to determine how much credit you’re utilizing at any given time (divide the amount charged by the credit limit to calculate the percentage).
This is one of the factors that goes into determining your overall credit score.
Since charge cards don’t have a pre-determined limit and the total amount charged is due with each bill, credit utilization isn’t taken into consideration.
Depending on when your score is calculated and if there’s currently a balance on your card, however, this could be factored into how much debt you owe in total.
Charge cards also have an impact on how the length of your credit history is calculated.
If the account is one you have held for several years, it could impact this part of your score in a positive way.
If it’s an account much newer than other accounts, it could potentially drag your average down.
However, even if opening a charge card has a small negative impact at first, holding the card and making on time payments can reverse this effect.
Charge cards can be a great alternative to credit or debit cards, especially if you are interested in reaping the benefits of a credit card without the interest.
But as with any account, it’s important to take into consideration the impact it has on your credit score -- both when the account is open and after it’s closed.