- September 11, 2014
- Posted by: Joel Firestone (G-Net Consulting)
- Category: News
Most people have a lot of questions surrounding the usage of credit cards. Should you have one? How many should you have? Should you have major credit cards or department store credit cards or both? How much should you use them? Should you pay them off every month? The list goes on and on…
Credit cards are a double edged sword. Having the right number of cards, using them wisely and paying them in the right way can significantly help a credit score. On the other hand one or two small mistakes with credit cards can destroy a credit score. It’s not just about late payments either. Even if you pay your credit cards on time every month, improper utilization can cause significant damage to a credit score.
Let’s start with whether you should have credit cards…Yes! If you don’t have credit you can’t get credit. This may go against everything your parents or grandparents ever taught you about money. “If you can’t pay for it with cash you can’t afford it.” Although there is some truth to that, having credit is necessary in the world we live in today. If you ever want to buy a home, a car, even get a rental, how much you pay for these things i.e. your interest rate is all going to be based on that three digit number that is your credit score. Those scores range from 350-850 and the higher that number, the better your interest rate is going to be. The best way to start establishing a good credit score and to maintain an existing good credit score is with credit cards.
Which ones to have, major credit cards i.e. Visa, Mastercard, Discover, etc or store credit cards….is one better then the other? Starting out getting a store credit card from Sears, Target, JC Penny etc. might be easier to obtain. Their guidelines are often not as strict as major credit cards. They do often carry higher interest rates and their penalties for late payments can be stiffer. But they are a good starting point for those just beginning to establish credit.
How many should you have? Optimally several. It used to be that the bureau’s scoring models did not want to see a lot of open credit cards with high credit limits because a borrower then had all that available credit and might be tempted to use it. If they were using all their money to make credit card payments every month then they might default on their mortgage payments. The current scoring models though consider it a positive attribute to see several open credit cards with low balances or no balances as it makes a borrower look like they are responsible with their money. They have the credit available to them but they do not use it.
Should you pay them off every month? Scoring models do not take into account if you pay off your cards every month. What they are looking at is the ratio between your balances and your credit limit. Let’s say you have one credit card that you use for business expenses every month. You travel a lot so every month it’s maxed out but you pay it off at the end of every month. Good! Right? Not necessarily…It all depends on when that credit card reports to the bureaus. Every credit card reports differently. Some report at the beginning of the month, some at the end, some in the middle, some twice a month, etc. So if you max out your credit card and don’t pay it down or off before they report to the bureaus, they are going to report that high balance and that can do a lot of damage to a credit score.
It would be better to spread your spending out between several different cards. That way you are not maxing any of them out. By using all of them occasionally you are not running the risk of the credit card company closing the account due to inactivity. Closing credit cards is also not helpful to a credit score and can hurt it. When you close a credit card you lose the history. The longer the history you have the better your credit score is going to be. Carrying a small balance over each month on at least one card also will help your credit score. Your score can take a fairly heavy hit if you do not have at least one credit card that carries a small balance from month to month.
Lastly be sure to pay them on time. One thing to be clear about is a late payment is a late payment. A late payment on your mortgage or auto loan does not carry more weight then a late payment on a credit card. One 30 day late on even a small department store credit card can possibly drop your score as much as 100 points or more.
So… what is the optimal way to utilize credit cards? Have several that are open. Keep your balances below 20% of the credit limit. Don’t close them. Use them all and carry a small balance on at least one every month. And make your payments on time. This utilization will result in a happy and healthy credit score.