Using Credit Cards to Build your Credit Score

by : Paul Basco

Using credit cards to build your credit score can be a very effective means to establish good financial habits and credit-worthiness. But, you have to be very careful as credit cards, if used irresponsibly, can wreck your credit rating in a very short period of time, and cause damage that will take years to overcome. When used responsibly, however, they have the reverse effect...a great credit score, in a short amount of time.

Getting Started With Credit Cards
One of the more common problems for people when they're just starting out with credit cards is that they have little or no credit history. It's a Catch-22, because how can you get a credit history without a credit card? Fortunately, credit card companies have become much more open to issuing credit cards to younger consumers, or those with little credit history. Here are some other options:

  • Secured Credit Cards
    Secured credit cards commonly require you to maintain a balance in a checking or savings account that can serve as "collateral" in the event that you miss or are late on a payment. For example, a $500 line of credit must be balanced with a $500 balance in the account.
  • Credit Cards Issued by Retailers
    Credit cards that are issued by major retailers like Sears or Target (for example), are typically easier to get because those stores want you to do business with them. They often come with a very low credit limit, but if used responsibly, they can help to establish your credit score, and make you a more attractive risk for the major credit cards.
  • Getting a Co-Signer
    A co-signer with good credit, typically a parent, is another common way to build your own credit score. Basically, they are liable for your charges if you fail to comply with the terms of the payment plan. But if you handle credit well, they may give you the option of removing the co-signer's name from the account.

Smart Credit Card Management Habits

  • Pay your Bills on Time and Pay More than the Minimum
    This rule is listed first because it is the single biggest factor in responsible credit card usage. The importance of honoring this rule cannot be overstated. Paying your bill on time is the easiest way to indicate to lenders that you are a conscientious and reliable manager of credit.

    Paying more than the minimum is also an excellent habit to get into, as the minimum payment generally required is only about 2% of the balance and most of that will go to the interest, and very little is applied towards the principal.

  • Reduce Credit Card Balances
    Credit card balances are generally referred to as "unsecured debt" in the lending industry, and because they are unsecured by any collateral, they pose a much larger risk for default. A good rule of thumb is never borrow more than 30% of your credit limit.

    Outstanding debt accounts for approximately 30% of your credit score, and the larger the balance on your credit card, the more of a 'risk' you appear to be. Plus, depending on your interest rate, a higher balance can literally cost you thousands of dollars, thereby making it even more difficult to pay down the principal.

    Always pay more than the minimum required on each credit card statement and you can reduce those balances more quickly that you might think!

  • Avoid Balance Transfers of Credit Card Debt
    The credit card industry is fiercely competitive, and they are always trying to steal customers away from each other with introductory rates that make them seem like a more attractive option. But, after a period of time, those rates always go back up which, unless you are able to pay the balance in full, result in very little savings to you. Plus, as far as the credit bureaus are concerned, debt with one card is the same as debt with another, which does not aid you in your quest to build your credit rating.

As you can see, there are many ways that credit cards can positively and negatively affect your credit rating. But, if you are using credit cards to build your credit score, a little caution and a lot of careful money management will make all of the difference, and you will be able to negotiate with lenders from a position of strength that opens up all kinds of other options for you.