When it comes to building your credit score, credits cards can be both your best friend or your worst enemy . Depending on how you use them, they can build your credit score or completely destroy it.
That is why it is so important to understand how credit cards can impact your credit score.
Owning a credit card
Overall, owning a credit card is good for your credit score. When building credit, the first credit product you have is usually a credit card. The longer your credit history, the better.
We recommend having a credit card once you turn 18 , even if you aren’t going to use it. In turn, you will maximize the length of your credit history.
Accounting for an average of 10% weight on your credit score is your credit mix (different types of debt). Credit scoring systems are looking at revolving debt (loans like credit cards that are open ended and have variable interest rate) and installment debt (loans like car payments which are paid regularly for a set amount of time). Having a credit card can add to your credit mix and increase your credit score.
Minimum monthly payments
Before you get a credit card, you must understand when you make purchases with your credit card, you will be required to make minimum monthly payments by the payment due date. This payment is the lowest possible payment to avoid penalties.
Minimum monthly payments are calculated as a percentage of your balance including any fees. So no, your minimum payment does not stay the same. The higher your credit card balance, the higher your minimum payment.
Your credit score is affected by how you manage your credit card payment.
First, if you are paying off your entire balance by the payment due date, you are setting yourself up for a good or excellent credit score. By doing so, lenders know that you manage your finances responsibly and do not live beyond your means. You are telling them, it is safe to loan me money.
If you miss payment on your minimum monthly payment, you will be charged a late fee. Once your minimum payment is 30 days overdue, your credit score will be impacted. The credit card issuer will send a late payment report to the credit bureaus. Unfortunately, your late payment will stay on your credit report for 7 years. This late payment will most likely impact your credit score particularly in the first few months of the report. However, if you make payment on time consistently, over time your credit score will increase.
Credit utilization ratio
Another impact of credit scores is your credit utilization ratio. This ratio is the amount of debt you are carrying (balance) divided by the amount of available credit you have. Say you have a credit card with a limit of $2000. Your credit balance is $500. Then you credit utilization ratio is 0.25 or 25%.
Here is more complicated example:
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Your credit utilization ratio would be $2176 divided by $8000 and comes to 0.27 or 27%.
Credit bureaus use your credit utilization ratio as a factor for determining your credit score. The lower the ratio, the better. Of course, there will be changes to your balance throughout the month. But the best way to manage your credit utilization ratio is to keep it below 30% at any given time. Increasing current credit card limits can lower your ratio, but will allow you to hold a higher balance.
Opening and closing credit card accounts
Everytime you apply for a credit card, the credit card issuer will run a credit check. This is called a hard inquiry that could decrease your credit score by a few points. Before you apply for a credit card, make sure you know your credit score before. That way you can predict if you will qualify for that card. You do not want to apply for multiple credit cards in a short period of time. This will lower your credit score as it shows you may be having financial problems. Spread out how often you are opening and applying for a credit card.
A benefit to opening credit card account pertains to your credit utilization ratio. By adding a credit card, you will have more credit available thereby decreasing your credit utilization ratio.
If you haven’t been using a credit or have dug yourself out of debt and don’t want the temptation, think again about closing your credit card account. Once you close that account, you are losing that available credit, which would increase your credit utilization ratio. If you aren’t using that credit card, put the card in a safe place and leave it alone.
If you don’t know your credit score, find out. Credit Sesame offers credit scores for free and it won’t affect your credit score.