Millennials are skeptical about credit cards. Is there really a way to use a credit card to build your credit? Yes, there is! Did you know that only 33% of millennials reported having a credit card in one Bankrate survey. Many people grew up hearing horror stories about large credit card debt from Baby Boomers and Gen Xers. However, credit cards, when used properly, help people establish a solid credit history.
Build your credit with your credit card: These 9 ways will show you how:
1. Use a Secured Card to Get Started
If you have no credit history, a secured credit card is a great tool. You deposit a set amount into an account. Your lender then gives you a credit card backed by those funds.
Issuers generally set a credit limit that is equal to or slightly larger than the deposit amount. For instance, a $500 deposit results in a credit limit of $500-$1,000. Keep in mind, a secured credit card otherwise works the same as a regular credit card. If you charge $100 to your card for gas or groceries in a month, you are responsible for paying that $100 back to the lender. These cards charge interest, and if you miss payments, the issuer takes the collateral.
2. Begin as an Authorized User
Becoming an authorized user on someone else’s credit card is another strategy you can take to build your credit and work your way towards an unsecured (i.e. regular) credit card. An authorized user can buy items such as gas on the card and the account holder is responsible for the bill. Parents often use this strategy to help a child build up his or her credit score.
Missed payments and high credit utilization by the account holder can impact your credit score. Make sure the account holder is reliable and that the two of you agree on what constitutes acceptable use of the card. If the cardholder considers your purchases irresponsible, your relationship will suffer.
Not all credit card companies report on authorized users. This fact means you must confirm that your information will show up on your credit report. The whole point of being an authorized user is to build up that credit report.
3. Timely Payments Are Key
You qualify and receive your first unsecured (i.e. regular) credit card. Now it is entirely up to you to keep a strong credit score.
Experian notes that your payment history is one of the biggest components of your credit score. When you get a credit card, you need to understand the payment terms. Make sure you are diligent about paying your bill by the due date.
Late payments stay on a credit report for 7 years. Set up a personal system so you do not miss payments. When prospective lenders see late payments of more than 30 days, they assume you are a greater risk, and charge interest accordingly.
4. Don’t Max Out the Card
The percentage of credit you used versus the amount of credit available is your credit utilization. If you make $900 worth of charges on your one credit card that has a $1,000 limit, you have 90% credit utilization. Yikes!
High credit card utilization means you’re at increased risk of default. A quick survey of financial advice literature shows that most experts recommend keeping your credit utilization under 30%. A low utilization ratio is important to earning a high credit score. This fact means you should only use a high percentage of your available credit in a true emergency.
5. Establishing Long-Term Lending Relationships
Closing credit cards can have a negative impact on your credit score for two reasons. Frist, TransUnion states on their blog that having a long-standing, well-maintained account helps your credit score. The reverse means that closing an older account hurts your score if your remaining accounts have a shorter history.
Second, closing an account increases your credit utilization ratio. If you have two cards with $2,000 limits each and you close one account, your entire credit utilization rate is based on that one account.
6. Getting Comfortable with Negotiations
Your first unsecured credit card is likely to have a high-interest rate. However, you can always negotiate a lower rate. Companies want to retain current customers that pay their bills on time and have a good credit utilization rate.
Asking for a rate similar to ones you receive in the mail improves your chances of winning a rate decrease. This type of exercise gets you accustomed to researching and inquiring about better rates for other financial products such as mortgages and car loans. Use your credit card to build necessary negotiating skills.
7. Be Careful About Getting More Credit Cards
Furniture stores, gas stations, and banks want to offer their customers a credit card. While having multiple credit cards is not necessarily bad, you need to make sure you can keep up with the payments. Again, if you are more than 30 days late paying a credit card, it has a noticeable impact on your credit score.
You can also get in trouble with numerous accounts is if you build up high credit utilization. If you have $25,000 in total balances on 5 cards and the credit limits of all cards combined is $50,000, you have an enormous 50% utilization rate.
8. Beware of “Hard” Inquiries
A hard inquiry is when a potential lender checks your credit. According to TransUnion, this action lowers (at least somewhat) your credit score. A truism of credit experts is to avoid hard inquiries if you are going for a large loan such as a mortgage.
Late payments, a high credit utilization rate, and hard inquiries lower your credit score. That is why many financial experts advise you to get the amount of available credit you truly need.
9. Learn to Audit Your Credit Report
When you get a credit card, you need to make sure your credit history is accurate. One Federal Trade Commission study found 20% of consumers overall had at least one error their credit report. Calling and getting errors corrected is an important step to guaranteeing that you have the best credit.
Earn Lower Interest Rates
By establishing good credit early, you avoid high interest rates on large purchases such as a home. A person who qualifies for a 5% mortgage on a $250,000 home pays $53,000more interest over the course of a 30 year mortgage than a person who qualifies for a 4% mortgage. A strong credit history saves you money.
In addition to lower interest rates, credit cards can offer you convenience and other benefits.
When Credit Cards Benefit You- Travel
Many people assume they can just use a debit card for their purchases. Credit cards offer benefits to travelers in addition to miles and/or rewards. A car rental company might perform a credit check on you if you use a debit card. The company can then refuse to rent to you if you have insufficient credit. Also, a credit card might offer an auto rental collision damage waiver that saves you from having to purchase rental insurance from the car company.
Some credit cards offer travel protection such as lost or damaged luggage insurance, trip cancellation insurance, and/or hotel burglary insurance. Make sure you know if your credit card has these features. Booking a hotel room is also easier with a credit card because you do not have to pay the large security deposit associated with a debit card.
Identity Theft & Purchase Protection
With concerns about identity theft, credit card companies have services to assist you. MasterCard offers ID theft alerts, emergency wallet replacement, and resolution services to U.S. cardholders. Discover allows card members to activate a Social Security Number alert feature that lets you know if your number shows up on suspect websites.
Some credit cards offer different types of purchase protection. Check to see if your credit card offers extended warranties. Return and price protection might be a benefit to your card. Also, certain cards protect you if your purchase is stolen or damaged. Review the website associated with your credit card brand to see if you are missing out on any benefits.
Rewards for Responsible Credit Use
Lenders look for borrowers with a mix of credit such as a car loan, mortgage, and at least one credit card. Optimize your credit score by:
- Building a good payment history
- Keeping all credit card balances low
- Having good long-term relationships with issuers
- Limiting hard inquiries
- Making sure your credit report is accurate
Start with a secured credit card or as an authorized user to establish a credit history. Once you get an unsecured credit card, use the 9 ways to build an excellent credit history.
You might believe that cash or a debit card is the best way to go for purchases. Without a good credit history, you will either not qualify for a mortgage or car loan, or you will pay a much greater amount in interest. You also miss out on credit card features and benefits that make travel, purchases, and identity dispute a little easier. Overall, you save money and gain convenience by using credit cards to build credit now.