How to Use Credit Cards to Improve Your Credit Score
It is widely known that higher credit scores make it easier to get loans and lower borrowing rates. However, it can be difficult and confusing when it comes to improving your credit. This is especially the case for people who are new to credit or have had problems with credit in the past.
Fortunately, there are many ways to improve your credit rating. One common and easily accessible approach through positive credit card usage. However, there are some things you should be aware of before you begin your journey toward a better credit score with a credit card.
Understand How Credit Scores Work
Credit scores come in many forms - you don’t just have one. Each of them may look at certain factors in different ways to determine your score. To make matters worse, the formula to calculate a credit score is strictly top-secret.
Generally, the credit score you should be most concerned about is the FICO credit score. The FICO score is used by more than 90% of major U.S. lenders when handing out credit cards and loans.
These are the factors that go into the calculation of your FICO score and how much each factor affects your score:
- Payment history (35%): Because much of your FICO score is based on the number of late payments on your accounts, it’s crucial that you make your payments on time every month. This rule applies to all type of credit, including credit cards, students loans, and mortgages. Late payments can cause a significant drop in your credit score.
- How much you owe (30%): After your payment history, the next most important part of your credit score calculation is based on the amounts you owe and how much you can borrow. It’s important that you pay down what you owe and keep balances as low as possible. It will help if you also have high credit limits because that will show that you're using a smaller percentage of the credit that's available to you. If you have a large amount of debt compared to the credit available to you, that can indicate to creditors that you're overextended.
- Credit history length (15%): This part of your credit score is based on how old your accounts are and the last time you used your accounts. Therefore, it would be wise to keep old accounts open and make sure you use them occasionally. This portion of the credit score is one of the reasons why it can be difficult for those without credit histories to qualify for credit cards.
- Credit mix (10%): The ability to handle different kinds of debt is a good sign to lenders. Having a mixture of credit cards, installments loans, and other types of loans will bode well for your credit score.
- New credit (10%): When you apply for multiple new credit accounts at one time, it's clear to lenders that you're shopping around with the intent to act. But if you consistently do this for months at a time, it becomes apparent to lenders that you're desperate and your credit score will start to decrease as a result.
Pick the Right Credit Card to Boost Your Credit
There are many types of credit cards that are available, but not all of them are ideal for people who want to improve their credit. Some cards are easier to qualify for with little credit or bad credit. If you're in this situation and obtain one of these cards, you can use them to start exhibiting good behavior with credit and begin the process of improving your score.
Here is a quick overview of the cards you can consider:
Credit Cards for Improving Credit
|Type of credit card||Pros||Cons|
|Bad-credit credit card||It is an unsecured credit card designed for people with bad credit.||High APRs and possible annual fees.|
|Secured credit card||You can raise your credit limit by increasing your security deposit.||Requires upfront cash as collateral.|
|Retail credit card||Easy to qualify for.||May be limited to store purchases only.|
There are credit cards designed for people who have bad credit or no credit. The caveats include annual fees, high interest rates, and low credit limits. However, the downsides are temporary because you can use these cards to increase your credit score and then apply for better cards.
If you have some cash to put down as collateral, secured credit cards are the ideal choice. Secured cards mostly act like regular credit cards except for the fact that they require collateral and the fact that the collateral often dictates your credit limit. And, if you show that you can use a credit card responsibly for an extended period of time, you might be upgraded to an unsecured card.
Another type of credit card you can start out with is retail credit cards. Retail credit cards, such as those available from certain brands and stores, are among the easiest credit cards to qualify for. But, be prepared for low credit lines and the potential that your card may only be used for purchases under that specific brand (this rule will vary per brand). Either way, these types of cards can make a good starting point to build credit.
Tips When Using a Credit Card to Raise Credit Scores
Before you get a credit card with the purpose of raising your credit rating, you should have a strategy ready. Here are a few tips that you can follow to ensure that you'll make good progress:
- Pay off your balance in full, every month. No credit and poor credit usually mean credit cards come with higher APRs. In order to avoid paying high amounts of interest that can quickly snowball out of control, you should focus on paying your entire monthly balances in full by the end of the billing cycle. Otherwise, your credit card is going to end up costing you extra money and can potentially make your credit worse.
- Keep a low balance. Don’t max your credit card out, as this can lower your credit score (and lead to difficult-to-pay-off debt). If you can’t pay your balance in full every month, try to keep the balance as low as possible and pay it off as soon as you can.
- Carrying a balance won’t help. One of the myths of the past was that you had to carry a balance from month to month in order to improve your credit rating. However, this is not only untrue, it also means you’ll be paying interest on that balance every month. You can pay your balance in full every month and improve your credit score, without paying additional interest for your purchases. Your card balance is still reported to the credit bureaus every month and that's what really matters.
- Get the highest credit limit possible. If you refer back to the factors that affect FICO credit scores, note that a high credit limit contributes to a higher credit score. With an unsecured card, you should call to request a credit line increase after 6 months. With a secured credit card, you should try to put down the maximum security deposit and, when you've hit the required amount of time by your lender, ask for an upgrade to an unsecured credit card with a higher credit limit.
Getting a Credit Card Can Also Hurt Your Credit Score
Credit cards can be a great tool for building and improving your credit score, but they can also be very dangerous when not used properly. It doesn't take long for one unpaid monthly balance to turn into two and then three and then many more that you fall into debt for several years.
Why is it so easy to fall into debt? The combination of high credit card interest rates and confusing minimum payment structures leads to a slow creep that builds a scary amount of momentum over time. The best way to avoid credit card debt is to pay off that balance every month. If that seems unreasonable, then only use your credit card for charges that you can pay off every month, such as gas and groceries.
Debt isn't just damaging to your finances, it's also extremely damaging to your credit score (thanks to the focus on credit utilization). All around, debt should be avoided as much as possible. It's important to understand exactly how you intend to handle a credit card before you apply for one, so you have supporting habits in place to ensure that you don't fall into debt.
Other Ways to Increase Your Credit Rating
While a credit card is a useful tool for improving your credit, it's not the only tool for improving your credit. There are other ways you can get a boost, which could be better options, especially if the card is going to cost more than it’s worth. Other ways to increase your credit rating include the following:
- Paying down balances on other credit accounts
- Using card accounts you already have to establish a longer and more active history
- Getting a car loan, mortgage, or personal loan (since that will be reported to the credit bureaus)
- Being added as an authorized user on someone else’s account
- Catching up late payments and paying on time every month
- Addressing any negatives on your credit report
How Your Credit Score Can Affect Your Future Mortgage Rate
|Credit Score Range||30-Year Fixed Rate Mortgage||5-year fixed rate mortgage||7/1 ARM|
How Your Credit Score Can Affect Your Next Car Loan
|Credit Score Range||60-Month new Car Loan||40-Month Used Car Loan|
How Your Credit Score Can Affect Your Next General Loan
|Credit Score Range||HELOC||Home Equity Loan|
Should You Get a Credit Card to Improve Your Credit Score?
In the end, the best thing to do is examine your finances and your credit report to determine if getting a new credit card is going to be best for your situation right now.
If you have already taken care of any negative marks on your credit file and have paid down balances, a credit card could be a good opportunity for improving your credit rating.