How To Use a Credit Card to Build Credit
You can use your credit card for more than buying stuff
But if you’re rebuilding your credit score or starting from scratch, it can be difficult to get approved for a credit card in the first place. And, once you do have a credit card, it’s easy to damage your credit score and make it worse than before you started. That’s especially true if you don’t know the best ways to manage your credit cards.
Luckily, learning how to manage your credit cards well isn’t rocket science. By taking a few simple steps, you’ll be on your way to a better credit score and a brighter financial future.
Check Your Credit Score
The types of credit cards you’re able to apply for will depend on your credit score. So, before you get started applying for credit cards, it helps to know what your credit score is so that you can apply for the right ones.
Discover is one of several credit card issuers that offer free credit monitoring tools to anyone who signs up—whether or not they are cardholders. Discover’s service provides a version of the FICO credit score, which most lenders use. You can use the service to get a look at your current credit score.
According to Experian, one of the three major credit bureaus that collect and evaluate consumer credit information, your score can be classified as follows:
- Exceptional: 800-850
- Very good: 740-799
- Good: 670-739
- Fair: 580-669
- Very poor: 300-579
Use this information to narrow down which cards may be best for you. For example, if you have a "Fair" credit score (580-669), you can save time—and hard inquiries to your credit report—by waiting to apply for better credit cards until after you’ve built up your credit.
Understand What Goes Into a Credit Score
Your credit score is made up of several parts, each of which can affect your credit score in different ways. According to FICO, here’s what goes into your credit score:
- Payment history: 35%
- Amounts owed: 30%
- Length of credit history: 15%
- New credit: 10%
- Credit mix: 10%
These are broad categories, and there are several ways that each one can affect your credit score. For example, while “amounts owed” comprise 30% of your overall score, FICO will actually consider what types of debt you have differently. It’ll look at how much debt you have overall, how much of your available credit you’re using, and how much you still owe on revolving debt (credit cards) and installment loans like student loans and mortgages when it calculates your score.
It sounds confusing at first, but it’s also good news for you: it means that you have a lot of options for improving your credit score.
Consider a Secured Credit Card
If you have bad credit (or no credit), one option is a secured credit card. These are available to just about anyone, but there’s a catch. You have to put down a refundable deposit to open the account, often of several hundred dollars. Usually, the deposit is also your credit limit.
All cardholders should treat their credit card accounts responsibly. This careful use is especially true for holders of secured credit cards. The high-interest rates and extensive fees that often come with these cards mean mistakes or lapses can get very expensive, very fast.
Opening a secured credit card and managing it well can help nearly every aspect of your credit score. For example, if you make all of your payments on time, you’ll establish a track record of positive payments. And if you keep your card open long enough, you’ll develop a lengthy credit history.
Secured credit cards often include additional fees that standard credit cards don't have and higher interest rates. But they are real credit cards and will help you build credit.
Once your score is high enough to be approved for better cards, you can consider closing your secured card if you wish to save money (your deposit will be refunded if your account is paid in full). Your secured credit card issuer may even invite you to upgrade your card to an unsecured credit card after a period—and refund your deposit.
Avoid Getting Too Many Credit Cards
It can be tempting to sign up for lots of credit cards, especially with the rewards and special offers for in-store financing. While there’s nothing wrong with opening up more than one credit card account, there are no simple rules about how many cards are too many. However, there definitely comes the point when managing multiple accounts is more trouble than it’s worth.
If a new credit card will tempt you to buy more than you can afford, or if you might have trouble remembering to make the payments for the new card along with all the rest, don’t open it. These things will only hurt your credit rather than help it. Furthermore, each time you open a new card, it’ll be listed as an inquiry on your report, which can drop your score for up to a year.
Always Make Your Payments On Time
The biggest factor affecting your credit score is whether you make your payments on time. Just one missed payment can have a significant impact on your credit score. Even worse, the mark will stay on your credit report for seven years, although the negative effect will fade over time.
The good news is that you can completely avoid missed payments by committing to make those payments on time, every time. One trick is to set up autopay on your credit card account for at least the minimum payment due each month.
Keep Your Balances Low Or Better Yet, Nonexistent
The second-biggest factor affecting your credit score is how much debt you have, especially relative to your available credit. This figure is known as the credit utilization ratio, and it’s simply a measure of your combined credit card balances compared to your total credit available.
For example, let’s say you have two credit cards, each with a $5,000 limit. If you have a balance of $1,500 on one and $3,500 on the other, your credit utilization ratio is 50% because your combined balance is $5,000, and your combined limit is $10,000.
Most credit experts advise keeping your credit utilization ratio below 30%. The lower, the better—and best of all, is if you can pay off your balances entirely, and not owe any credit card debt.
You can do this by only charging what you can pay off every month. You can also make multiple, smaller payments each month to keep your spending under control and avoid any surprise, monster bills at the end of the month. Doing so will give a boost to your credit score, and you won’t owe any interest if you pay your balance in full each month.
Instead of making a single monthly credit card payment, consider making two or several smaller payments. First, you will reduce the balance that the bank reports to the credit bureau, slightly improving your utilization ratio. Second, as finance charges are often calculated based on the average daily balance, you can shrink the interest you pay by reducing daily balances earlier in the billing period.
Keep Your Old Credit Cards Open
The length of your credit history is a relatively minor factor in determining your credit score, but it’s important nonetheless. To calculate this factor, credit scoring models will take the average age of all of your accounts.
This timeframe calculation means that by keeping your oldest credit cards open, you can keep a lengthy credit history that will boost your credit score higher. If you close those old credit cards, your credit history will be cut short, and your score may drop as a result.
Of course, there are also times when it’s still worth closing an old credit card. If it has a high annual fee and you’re no longer using it, you should close it. And if that old card tempts you to revive some old, bad spending habits, then you should definitely close it.
Keep an Emergency Fund
People often fall into credit card debt because life’s surprises pop up, and it’s just easier to put the expenses on a credit card and pay them off later. But for many people, “later” never really happens because emergencies keep popping up, and those new expenses join the old on the credit card. This use causes your credit card balance to swell, which makes utilization ratio worse, and that leads to a lower credit score.
The best way to break this cycle is by keeping a separate emergency fund. That way, you can use your credit card to cover the emergency costs if you wish (especially if you’ll earn rewards from it), but you can also pay off the charges right away and stay out of the debt cycle.
You Can Use Credit Cards to Build Credit
Using credit cards to build credit is a double-edged sword. If you wield it well, you can boost your credit and unlock doors that weren’t open to you previously. But if you aren’t so good at managing your credit cards, it can harm your credit score even more.
It’s important to be honest with yourself about whether you can use credit cards responsibly. If you are, you’ll be well on your way to a better credit score.