If used responsibly, credit cards can be excellent tools for building your credit score. However, the reverse is also true: If you make mistakes with your credit cards, you can negatively impact your credit score.
Credit cards and credit scores have a close relationship. Once you understand how the two are connected, you can use the information to maintain—and even boost—your creditworthiness.
Applying for credit cards
Each time you apply for a credit card, the credit card company reviews your credit report to determine if you qualify. This is called a “hard inquiry,” and it could possibly reduce your credit score by two to five points.
One hard inquiry isn’t a big deal, but if you apply for a lot of credit cards at one time, it may negatively impact your credit score. Take a thoughtful approach, and don’t apply for a credit card every time you get an offer with a great deal attached.
Balances on your credit cards
Your credit utilization ratio is the amount of credit used compared to the amount of credit you have available on your credit cards. It factors into approximately 30 percent of your credit score.
For example, if you have two credit cards and they each have $500 limits, then your available credit is $1,000. If your total balance on both cards is $200, then your credit utilization ratio is 20 percent ($200 divided by $1,000).
Because your credit utilization ratio accounts for so much of your credit score, it’s particularly important to pay attention to the balances on your credit cards. If your utilization ratio is higher than 30 percent, it could negatively impact your credit score. Lenders use the information in your credit report, along with other information, to calculate your risk as a borrower, and they may look more favorably on borrowers with a low ratio.
Closing a credit card
Closing an account could impact your credit score because you’re losing the credit limit attached to that account. If you have balances on other accounts, the closing of an account could increase your credit utilization ratio because it will cause you to have less available credit overall.
Closing a credit card account you’ve had for a long time can also impact your credit score because you will lose the associated history with the card. The length of your credit history makes up 5 percent to 7 percent of your Equifax credit score.
Making late payments
Your payment history is the biggest factor considered when calculating your credit score— it accounts for approximately 35 percent. If you make late payments, your credit score could be impacted.
Obviously, this means it’s important to pay your bills—including your credit card bill—on time. Even a late cell phone bill could get reported to the credit reporting agencies and appear on your credit report. Be sure you have a good system in place so you aren’t late on any payments.
Building your credit history
You need to use your credit card to build a credit history and credit score. In order to build a credit score with a credit card, you need to have an active credit card account for about six months.
This doesn’t mean you need to go out and spend a lot of money. Just make small purchases—such as buying groceries or fueling up at a gas station—and pay the bill in full by the due date.
Having a card and not using it will not help you build your credit file. Use your credit card, keep low balances, and pay the bill in full by the due date. With responsible use, you can positively impact your credit score over time.
Beverly Harzog is a nationally recognized credit card expert, consumer advocate, and the author of Confessions of a Credit Junkie: Everything You Need to Know to Avoid the Mistakes I Made. She runs a popular credit card blog on her website, www.BeverlyHarzog.com.
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