Building Credit: Cultivating a Healthy Relationship with Credit Cards
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Knowing what is a good credit score is only one aspect of learning how to build a good credit score. Cultivating a healthy relationship with credit cards — including knowing how to use them responsibly — is one of the keys to building and maintaining great credit. By understanding the behaviors needed to build credit, you can start assessing where you’re at in your credit journey and take necessary steps to reach your desired score.
Benefits of Using Credit Cards Responsibly
Credit can be a useful tool to help you reach your financial goals, whether it’s buying a house, replacing an older vehicle, or getting a new credit card. Using credit cards responsibly is one way to ensure that they remain a useful tool instead of potentially hindering your financial future.
By using credit cards responsibly — like making on-time payments — lenders view you as a less risky borrower. Meaning, you’re more likely to pay back loans on time, helping lenders remain profitable.
Approved for Better Loans
Since you appear to be less risky for lenders, you’re more likely to be approved for loans with more favorable terms and more competitive interest rates. The lower your interest rates are for any loan you take out, the more you can save. For example, even a fraction of a percent lower in your mortgage rate could result in thousands of dollars in savings on interest charges throughout the life of your loan.
Avoid Paying Credit Card Interest
You could avoid paying credit card interest altogether with responsible usage. Credit cards offer a grace period before interest charges kick in for purchases. As long as you pay off your entire balance by the due date, you aren’t responsible for any interest charges. You may even be able to qualify for credit cards with introductory 0% APR (annual percentage rate) periods. If you intend on making a larger purchase, you may be able to spread out the payments interest-free until the introductory period is over.
Increase Your Chance of Getting Luxury Credit Cards
Using credit cards responsibly can help you increase your chances of being approved for credit cards with better benefits. Many credit card companies, in an effort to retain customers, offer credit cards with perks such as earning rewards towards travel or cash back. The higher your credit score, the more likely you are to be approved for these types of cards, helping you nab free flights, hotels, and more.
With the potential savings in interest rates and receiving free perks, you can free up the money you would have paid toward debt towards other financial goals, like saving for a down payment on a home or expanding your family.
Are You Building or Hurting Your Credit Score?
Life happens, and sometimes managing the day to day matters of our finances can take a backseat. Being able to monitor your credit score regularly will ensure you know where you stand. Specifically, whether the actions you’re taking are helping to build or are in fact, hurting your credit score.
The higher your credit score, the less risky you appear to lenders, so working towards that as a goal will benefit your finances in the long run. Although ranges may differ depending on the scoring model, anywhere between 670 to 739 is considered a good credit score. Lower than this, and you’re more likely to not receive as many benefits, such as lower interest rates or being approved for more favorable loan products.
A clue into whether you’re hurting your credit score is if you see it go down over time. In some instances your credit score may take a dip temporarily, like when you apply for a new loan or credit card. However, if it remains low (or lower than you’d like), then it may be time to look into why your credit score may be where it is.
Common Practices for Responsible Credit Card Usage
Whether you have healthy credit or are working towards getting there, here are some best practices to consider when it comes to using your credit cards responsibly:
- Make on-time payments: Your payment history is one of the most important factors credit scoring companies look at when calculating your score. It’s also what lenders look at when assessing the type of risk you may pose as a borrower. The more consistent you are with on-time payments, the more responsible you appear to be.
- Regularly monitor your transactions: Despite your best intentions, sometimes thieves can get a hold of your credit card information. By checking your credit card transactions on a regular basis, you can spot any fraudulent activity and report them to your credit card issuer as soon as possible.
- Be mindful of purchases: The more you rack up purchases on your credit card and keep a balance each month, the more it can affect your debt-to-income ratio (DTI). This ratio measures the amount of debt you have compared to your gross income and is a way for lenders to assess whether you have the means to manage any new loans you plan on taking out. The higher your DTI, the more likely it seems that you are being stretched too thin financially. By being mindful of the purchases you make, you can keep your DTI to a reasonable level.
- Keep your credit utilization low: A credit utilization ratio is the percentage you are using of your overall credit limit on revolving loans (like credit cards and lines of credit). The higher your credit utilization, the more it appears you need to rely on credit to get by. A rule of thumb most follow is to keep your credit utilization at 30% or less, and you can get there by paying down your balance or not racking up a high number of purchases in the first place.
What Happens When You Misuse Credit Cards?
Behaviors such as being late on payments or missing them altogether or maxing them out consistently could result in some negative consequences. For one, your credit score could go down, putting you at risk for not being approved for loans (perhaps for a car or house) in the future.
Even if you’re not looking to take out a loan, having high balances on your credit card could mean you’ll struggle to keep up with payments. If so, being behind on bills can cause a lot of stress and worse case, lead you to having your bills go into collections or filing for bankruptcy.
Disclosure: Consumer Insite has partnered with CardRatings for our coverage of credit card products. Consumer Insite and CardRatings may receive a commission from card issuers.
