Credit Card Smarts
Credit cards often get a bad rap. But by themselves, they are not necessarily evil. They can actually be useful tools in building a good credit history -- and that will save you money for the rest of your life. (See Why Your Credit Score Matters to learn more.)
It's how people use their credit cards that can get them into trouble. Some bad credit-card habits are easy to spot. Others are not so obvious. Some seemingly innocent moves could actually be hurting your credit score and you don't even know it.
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Knowing how to use your credit wisely and responsibly is key to your financial well-being. So whether you're heading off to college, starting out as a recent grad or simply renewing your resolve to manage your money better, here are seven habits to get you on the right track:
1. Take it slow. Credit comes fairly easily these days, especially for college students. But rushing into your first credit card -- or applying for several cards all at once -- may be dangerous to your financial health.
Let's look at students, for example. The average college senior has nearly $3,300 in credit-card debt by the time he or she graduates, according Nellie Mae, a student-loan provider. Plus many have thousands of dollars in student-loan debt on top of that. When the bills come due and interest charges pile up, too many students realize they took on more than they can handle. Better to wait until you're certain you're ready for the responsibility of credit. And stick to just one or two cards at first. (See Just Say No to Credit to learn more.)
Not a student? It's still important to take it slow. If you apply for too many cards in a short period of time, you'll hurt your credit score because lenders worry that you'll go on a spending binge. Start with one or two cards and assess your need from there. Building your credit history one step at a time helps reduce temptation to overspend and keeps your credit managable.
2. Start building credit safely. Practice makes perfect, and you don't necessarily have to dive right into a credit card to start building your credit history. A good way to dip your toe in the pool is with a secured credit card. It works just like a regular one -- and builds a credit history, too -- only you put down a deposit with the bank equal to your credit limit. That money acts as collateral. If you don't pay your bills, the bank keeps your money. With your own cash on the line, it's psychologically easier to take credit seriously and realize it is really not free money. After a year of responsible use, you can graduate to a regular card and get your deposit back. (Secured cards are a great way to get a credit card if you're starting out and cannot get approved for a traditional card.)
Also, you can sign up at Payment Reporting Builds Credit, a credit bureau that tracks recurring bills -- such as rent, utilities and cable -- that aren't traditionally reported on your credit history. Fair Isaac, the company that provides the industry standard for credit scoring, takes info from PRBC into account. See Rent Your Way to Good Credit for more information.
3. Charge only what you can afford to pay. Remember Wimpy, Popeye's friend who would "gladly pay you Tuesday for a hamburger today?" Don't let him embody your philosophy with credit. If you can't afford it today, odds are you can't afford it tomorrow either. This habit of immediate gratification -- and payment procrastination -- is what gets so many people into financial trouble. For many of us, this comes down to knowing the difference between needs and wants.
It may help to view your credit card as an extension of your checking account -- like a debit card in credit-card clothing. Don't charge it unless you have the money in your account to cover it. To get the hang of things, jot down those credit card purchases in your checkbook register and deduct them from your account balance immediately.
4. Pay on time and in full. Sounds like a no-brainer, but we all have had those moments when we've simply forgotten to mail the check or pay our credit-card bill online on time. Your payment history makes up more than one-third of your credit score, so that little slip could turn into a biggie.
The simple solution is to arrange with your card company for your bill to be paid automatically and directly from your checking account -- and the service is free. No more stamps, envelopes or head-slapping moments of forgetfulness. Select the option to pay your bill in full each month. Contrary to popular belief, you don't have to carry a balance from month to month to build a credit history. Pay your bill in full without lifting a finger and you'll still have a solid score and sleep easier at night.
5. Don't max out your credit cards. Just because you have a $1,000 limit doesn't mean you should charge $1,000. Doing so could actually hurt your credit score -- even if you pay your bill in full by the end of the month.
Lenders are turned off by consumers who charge to the brink. You'll earn a much stronger credit score if you show restraint and keep your balances below 25% of your credit limit -- or $1,250 on a card with a $5,000 ceiling.
6. Know when to speak up and when to leave well enough alone. Credit cards are a business, and the companies want to keep you as a customer. Issuers know you can easily turn somewhere else if you're not happy with your card's terms. That's why it can pay to speak up. For instance, many people have had success lowering their interest rate or waiving an annual fee simply by calling the card company and asking. See Lower Your Credit-Card Rates to learn how.
But there's one instance in which you shouldn't be so eager to call the card company -- and that's to close old accounts. This actually lowers your credit score. Lenders look at the average age of all your accounts. A credit card you've had for ten years is a big boost, assuming your history with the account is good. If you want to close an account to remove the temptation of spending, it may be better to cut up the card and keep the account open.
7. Carry a balance? Do it right. Emergencies happen and even with the best of intentions, you may find yourself unable to pay your bill in full. Make the minimum payment on time and your credit score will come out okay. But it'll take you longer to rid yourself of that debt, and cost you more money in interest charges.
Pay as much as you can beyond the minimum required. You don't want to pay for this slip-up for months -- or even years -- to come. Calculate the true cost of paying the minimum for a real eye-opener.