Here's How Credit Cards Affect Your Credit Score
A credit card can be the single best tool you have available to boost your credit score. (And if you don't know how to use them responsibly, they can also act as the biggest threat to your credit worthiness).
Credit cards have an outsized impact on your credit score because they demonstrate to creditors your ability to take on and manage debt.
From opening new credit accounts to keeping your cards open for a long period of time, it's important to understand the various factors at play for how credit cards can impact your score.
Why having a credit card is good for your credit
A credit card is one of the easiest lines of credit to get—so if you have an insufficient credit history, opening a credit card is the best and easiest way to get a jumpstart on your credit.
Why do credit cards impact your credit score so much?
According to Experian director of public education Rod Griffin, “The consumer determines how much they're going to charge and how much they're going to pay each month, so there's that element of free will that you don't have with other types of debt.”
So if you can use a credit card responsibly, you can take advantage of this high impact to help boost your credit score.
And to help leverage your credit card use to improve your credit score, it's useful to understand how your credit scores are calculated in the first place.
Understanding how credit scores are calculated
Did you know that you actually have more than one credit score, and that each one is calculated a little differently?
What we mean is that you have a score with each credit bureau, and then you have scores with other companies, like FICO and VantageScore.
Each score is calculated using basically the same factors, but each company may weigh these factors a bit differently.
For the sake of this article, we're going to dive into how your FICO score is calculated because it’s the most common score lenders use to determine creditworthiness.There are five factors that affect your FICO score:
- 1Payment history (35%). How timely you have been with payments on your accounts.
- 2Credit utilization (30%). How much of your available credit you’re using.
- 3Credit history (15%). How long you’ve had active credit accounts.
- 4Credit mix (10%). How many various types of credit you have (i.e. mortgages, auto loans, credit cards, etc.)
- 5New credit (10%). How many times you’ve opened new accounts or applied for new credit.
Understanding each one of these factors can go a long way to utilizing credit card usage to help boost your credit score.
Opening new credit card accounts
It’s true that opening new credit card accounts is one of the best ways to build or rebuild your credit, but you should be ready to handle them responsibly before doing so.
Opening new credit card accounts increases your available credit, thereby decreasing your credit utilization—which can lead to a higher credit score.
It's worth pointing out that when you apply for a new credit card, it results in a hard inquiry on your report.
A hard inquiry will usually only take a point or two off your score, but if you apply for a lot of new credit cards at one time, it could start to make a difference.
Avoid running up high balances
If you do open a new credit card account or two, it’s important not to run up high balances—which can hurt your credit score a great deal.
The general rule of thumb is that you want to keep your total credit usage at 30% or lower.
For example, say you have a credit card with a $5,000 credit limit.
At any given time then, you don't want your balances on this card to exceed $1,500—or 30% of your available credit.
If you can keep your balances below this 30% threshold on your credit cards, it will got a long way to improving your credit score.
Making on-time payments
Payment history is the most important factor in calculating your credit score.
I will repeat: the most important factor.
Because it’s weighed more heavily than the others, it’s important that you establish a solid payment history as soon as you can.
If you can get into the habit of paying your credit card off in full, every single month, you will be successful in raising your credit score almost immediately.
Applying for a credit limit increase
If you use your credit cards responsibly, you can usually apply for a credit limit increase—which is a good idea if your credit utilization ratio is high and you need to add availability to your credit line.
Most credit card companies have guidelines about how often you can apply for this increase.
Some require you to be a member for six months, while others might require a year. And most companies require you to have an almost perfect payment record during that time to qualify.
How does a credit limit increase affect your credit score?
By increasing your credit limit, you are instantly decreasing your credit utilization ratio—remember, keeping this ratio below 30% is one of the most important factors when calculating your credit score.
Keeping your accounts open for a long time
You may think you're doing a good thing for your credit by cutting up credit cards and closing accounts.
But as far as your credit score is concerned, the longer you keep your accounts open, the better. The reason being that once you close an account in good standing, after seven years you lose "credit" for all those on-time payments that you had been making.
Let’s take someone who has had a pretty good payment history on a credit card for five years, but he decides to close the account to avoid the temptation of using it.
That may sound like a great idea, and he will probably even maintain his score for a while.
But in seven years, the last on-time payment he made on that account will fall off his report.
If he has other lines of credit he’s paid on time, this may not make a whole lot of difference. But, what if he never applied for or used any other credit?
In this case, he goes back to square one, with zero credit history—much like a teenager fresh out of high school.
How many credit cards should you have?
If you’re opening up new cards as a way to help your credit utilization score, you may be concerned about the number of credit cards you have.
And while there’s no simple answer for this, most experts agree that one major credit card is enough in the beginning.
For one thing, having too many credit cards can be too big a temptation to handle.
If you’ve already had financial problems in the past, it’s important you learn to manage one single card before adding to your debt responsibility.
If you end up having trouble juggling them, you could end up hurting your payment history, which holds even more weight than utilization.
The other thing to consider is your credit mix.
While it doesn’t make up a huge amount of your score, it’s important to make sure you vary your types of credit. Like we said, every point counts!
In short, we suggest using one card very responsibly for a year before considering opening another.
Credit card best practices
We never advise anyone to jump into opening credit card accounts irresponsibly. So, when you do, take a few pieces of advice with you:
Credit cards can build your credit score much quicker than other forms of credit, but they can also tank it just as fast.
Use them to your advantage, but do so responsibly, and you could be on your way to a better score much quicker than you imagined.