Used wisely, credit cards can help build your credit score and earn you sweet perks. But to get smart about the plastic in your wallet, you have to shake free from common myths that can actually tank your score or cost you unnecessary money.
1. YOU RELY EXCLUSIVELY ON A DEBIT CARD.
The perks of debit are clear: It’s harder to overspend than if you use a credit card, and you can’t work yourself into a mountain of debt. That debt aversion might explain why those of us who got our financial footing during the Great Recession are more leery of credit than other generations: According to a Bankrate survey, two-thirds of people ages 18 to 29 don’t have a credit card, compared with only one-third of people over 30.
“But it’s dangerous to assume that all plastic is treated the same way by credit reporting and scoring agencies,” says credit expert John Ulzheimer, who spent years at FICO and Equifax. “Only credit cards make it onto your credit report, so if you avoid them you’re really not doing anything to help your credit score or establish your credit report.”
Even if you don’t plan to apply for a car loan or mortgage anytime soon, when you are ready to apply, those lenders will factor the age of your credit report into their decision. Opening a credit card in your 20s will mean you have a more, ahem, mature credit report than if you open one in your 30s, which can help you get a better or bigger loan—even if your finances are otherwise unchanged.
The Truly Smart Move: Go ahead and apply for a credit card (free services like Credit Karma can help you determine the appropriate card). If you’re worried the new piece of plastic will tempt you to splurge beyond your means, don’t keep it in your wallet.
2. YOU CARRY A SMALL BALANCE EACH MONTH.
Credit scoring agencies want to see that you’re using your credit cards regularly, because that signals that you can responsibly handle the credit available to you. But somehow that truth morphed into a widespread myth that you shouldn’t pay your bill in full.
“Carrying a balance from month to month will just cost you interest and won’t help your credit score,” says Bethy Hardeman, chief consumer advocate at Credit Karma. In fact, it could hurt it, because lenders look at how the amount of your current balances compares with your total credit card limits. The lower the balance, the better.
So how do you prove regular use and earn your financial brownie points? Relax—credit card companies do the work for you. When you swipe your way to a $200 balance on your Visa, the company reports that amount to the credit reporting agencies at the same time that it issues you a bill. You can then pay that balance (in full!). And keep in mind that regular use doesn’t mean you have to use the card monthly or hit a certain spend threshold. Modest use every couple of months works just fine.
The Truly Smart Move: Set a calendar reminder so you pay your balance in full and on time to avoid getting hit with late fees. And if you find that “regular use” is turning into “regular splurges,” use your card to set up auto-pay on a boring bill instead. It’s tougher to be tempted to go on an electricity spree.
3. YOU DECLINE A CREDIT LIMIT INCREASE.
When Visa mails you an offer to increase the credit limit on one of your cards, you demur. Time for a pat on the back, right? Not quite. When FICO determines your credit score, one of the biggest numbers it looks at is your revolving utilization. Also known as credit card usage percentage or balance-to-limit ratio, this is basically a fancy way of saying how much you owe on your credit cards compared with how much your total limits are. “If you owe $500 on a card with a $500 limit, you’ll have a lower score than someone who owes $500 on a card with a $5,000 limit,” says Ulzheimer.
To calculate your current revolving utilization, divide your balance by the credit card limit and multiply by 100. Quick example: If you owe $1,000 on a card with a limit of $2,500, your revolving utilization of that card is 40 percent. While 40 percent might sound boss at first blush, consider that consumers with the highest credit scores tend to have revolving utilizations under 10 percent.
One way to better your revolving utilization is to pay down your balances. But another is to increase the credit limits on existing cards. So the next time MasterCard extends an offer, think twice before you decline.
The Truly Smart Move: Many credit card companies will reassess your limit every three years or so, when they reissue your credit cards. But you can also proactively ask for an increase. You’re more likely to secure a higher limit if you’re a low-risk consumer: You use your cards regularly and pay your bill on time.
4. YOU CANCEL SOME OF YOUR CREDIT CARDS.
Maybe your wallet is crazy cluttered with a million cards and you’re looking to streamline. Or maybe you’re sick of all the temptation that comes with having multiple cards. Or maybe you think having one card is safer when it comes to identity theft. No matter what your motivation, closing a credit card will ding your credit score, because it reduces your revolving utilization.
“Never, ever close a credit card,” says Ulzheimer. “The only time a card should be considered for the chopping block is if it has a huge annual fee and you’re planning to never use it again.” It’s especially worth waiting, he says, if you plan to apply soon for any type of credit, including an auto loan or student loan.
As for identity theft, keep in mind that if your account info is somehow stolen, all four of the major credit card networks offer total fraud liability. That means, if you spot a suspicious charge on your statement and you report it to the credit card company, you’ll pay nada.
The Truly Smart Move: The best way to kill both clutter and temptation—without wounding your credit score—is to shred the plastic you don’t want to use anymore. If you ever decide to start using that particular credit card again, you can put in a call to the company and have the card reissued at no expense.