If you’ve got a credit card, congratulations. Not only does it give you the power to make purchases conveniently, but it does more than that.
That four-inch plastic card you’ve got in your wallet can also help you buy bigger things.
Here’s the catch — you need to build credit. Luckily, your credit card, used properly and responsibly, can help you do just that.
The keyword here is “responsibly.” Use your credit card haphazardly, and you can find yourself with bad credit scores and debt.
It might seem odd that using a credit card can help you develop your credit score. However, it is possible if you know how to use a credit card to build credit.
In this article, we’ll fill you in on building your credit score with your credit card. We’ll also go over how banks and institutions determine your score to help you understand where your credit card use comes into play.
Are you interested? Let’s get into it!
Let’s start with the basics and define what credit is — at least in the context of finance. To illustrate the concept, let’s use an example.
Imagine two people borrowing your motorcycle:
Both seem equally capable of bringing your motorcycle back. You may be able to lend your motorcycle to either one of them.
However, you learned from your neighbors that the second person failed to return motorcycles in the past. You researched this person and learned that they have a history of smashing cars and motorcycles.
The question is: who are you more inclined to lend your motorcycle to? It would be to the first person given the second person’s history with motorcycles.
What does the above example have to do with credit? It’s simple.
Substitute the motorcycle with buying goods and services and the promise or understanding to pay later. This is how credit works.
To paraphrase Investopedia, credit operates on the principle of you buying things using a tender that isn’t money. This tender represents a financial institution’s trust that you’ll pay them back for the money they allowed you to spend.
In most cases, this tender is none other than your credit card. The credit card is your bank’s way of telling an establishment:
In a nutshell, credit is simply your ability to buy something without paying at the time of the purchase. At times, you pay a certain amount of money upfront but pay the rest later in a lump sum or installments.
A credit card allows you to buy things on credit. Let’s face it — credit is great when you need to buy something big.
So, why not just get a credit card, right?
Not so fast! Remember that you can only get a credit card from a bank or a financial institution.
And, unless you’re a member of the Royal Family or the Pope, no bank will just mail you one.
For ordinary folks like us, we need to prove that we’re “good for it” if you will. We prove our capacity to pay with a history of paying back debts completely and on time.
Just go back to the motorcycle analogy.
Our history of paid debts, bill payments, and purchases paints a picture of how well we can pay something off. This will make us trustworthy cardholders, at least in the eyes of banks.
Our history of payment transactions makes up our credit score. The Federal Trade Commission defines the credit score as a number that represents our ability to do the following:
If a bank gives you a decent one (anywhere between 630 to 850 points), you can get a credit card. So, having a good score is already proof that you have good credit in the eyes of your card provider.
Hence, with that in mind, your credit card isn’t just a four-inch piece of plastic for convenient shopping — it’s proof of good credit.
You can build your credit further for larger purchases using your credit card.
Now that we’ve gotten the basics and foundations out of the way, let’s go into some actionable information. More specifically, let’s talk about some of the ways you can build credit using your credit card.
Different financial experts — seasoned or otherwise — will swear by different techniques. Be that as it may, you’ll likely hear most if not all of them mention these five tried-and-tested credit-bolstering tricks.
Let’s start with the first — picking the right credit card.
Not all credit cards are the same — which is a good thing.
When we talk about credit card differences, we mean the credit scores that they contribute to.
Some credit cards require you to have a high credit rating or score. Others will make you eligible for a score that isn’t as high.
You might be considering applying for multiple cards all at once. We’re guessing that you’re thinking along these lines:
“What’s wrong with applying for a lot of cards at the same time? One will likely get applied.”
There are two problems you stand to experience with this approach.
In short, pick the right credit card that suits your credit score. This way, you maximize your chances of approval without sacrificing your credit score.
When you receive your credit card, you now have in your hands an object of power.
Granted, that’s a bit too hyperbolic. Nonetheless, it is as the cliche goes: “With power comes responsibility.”
By responsibility, we mean the responsibility to pay your credit card bill on time. When you pay your bill on time, you build up your image as a responsible cardholder.
Your timely payments will show creditors a pattern — one that proves your capacity to pay loans. The more frequent your timely payments are, the better.
On the other hand, any history of missed credit card bill payments will show up on your credit history. When they do, a lender or creditor will take notice.
In short, your ability to pay loans will make or break your credit. There’s no better way to show you can pay loans than by paying your credit card bill on time.
Besides, most credit card companies or banks have a surcharge for late payments. Nobody looks forward to that.
This is related to paying on time. Other than paying in a timely fashion, you’ll have to give the required amount when it comes time to pay the bill.
Indeed, some credit card companies have flexible payment options. These payment options can allow you to make payments later when you’re financially capable.
This may sound like a godsend. It probably is, in some cases.
However, when it comes to your credit score, it’s a different story. Opting for such payment alternatives can cause your credit score to take a serious hit.
Credit utilization is how much of your overall credit you regularly use or owe.
Credit is, once again, your capacity to purchase goods and pay later. Depending on certain factors like your starting credit score (pre-credit card), you will have something called a credit limit.
The credit limit is the maximum amount you can spend using your credit card. For instance, if your credit limit is $10,000, you can use your credit card for $10,000 worth of purchases or transactions.
Credit utilization takes into account your credit limit and how much of it you have left to pay. To build credit, you need your credit utilization rate to be low.
Why? In the eyes of creditors, a high credit utilization rate tells of the following:
Now, what exactly is a low credit utilization rate? You’ll get varying answers from different card issuers or banks.
While 0% is ideal, you just need to keep your credit utilization rate below 30%. You can achieve this by:
Canceling accounts may be an option, but it won’t do anything for your credit score.
Keeping your accounts open keeps you in the stream of credit. It will enable you to carry out transactions that will contribute to your credit history.
The longer you do this, the better your credit becomes. The reason behind the improvement in your credit score is that you become more trusted as you build credit.
The duration your account has been active is the credit age. If you have more than one account, the average age of each account is calculated to produce the average account age.
You want the average age of your account or accounts to be as high as possible. Don’t open too many new cards because this can cause the average account age to dip.
Here’s a tip: maintain your account or accounts for as long as possible. Also, try not to open too many accounts.
Bear in mind that more credit cards aren’t always assets. They can also become additional liabilities which you need to pay for monthly — and in full to maintain and build your credit.
Using your credit card to build credit is all about proving responsible card use and sustaining it.
To build your credit, you must begin by selecting a credit card that suits your current credit score. This maximizes your chances of being able to sustain the account and be approved.
Once you have your credit card, pay on time and in full. Doing this will reflect positively on your credit score.
Although you need to use your credit card, keep the percentage you owe low. If you’re tempted to close your old credit card account and open a new one, don’t do it.
Credit and loans can be overwhelming for anybody. That’s why we at 121 Financial Credit Union are here to help.
Our financial services on banking, loans, and credit can help take the guesswork out of your finances. For anything finance-related, don’t hesitate to reach out to us at 904-723-6300.