Getting approved for a new credit card is an exciting moment. You’re freshly equipped with a powerful tool that could help you build credit, earn rewards, and make major purchases with ease. While there are plenty of reasons you might want to use your credit card, keep in mind that the convenience could come at a cost – when used irresponsibly, credit cards can put you in debt, much faster than you might expect.
The Best Way to Use Credit Cards: Building Credit
Whether you’re new to using credit cards or looking to improve your existing credit, credit cards are the most common tool people use to build and rebuild their credit. Below you’ll find some tips on how to use credit tactically to help stay out of debt. Be sure to follow these best practices to keep your finances and credit as healthy as you can.
Keep Your Balances Low
Keeping a low balance on your credit cards could make it easier to pay balances in full and reduce the amount of interest you have to pay each month.
Use Less than 30% of your Credit Limit
Credit utilization, also called credit usage, is the ratio of your credit card balance to your credit limit. It’s a key factor in how FICO determines your credit score. Using less than 30% of your card’s credit limit is essential for maintaining a good credit score.
Pay Your Bills on Time
Payment history is another important factor in how your FICO credit score is determined. Paying bills on time ensures that you continue to build a positive payment history. Plus, paying your credit card bills on time guarantees that you won’t incur any late fees.
Pay More than the Minimum Due
The lower the balance that remains on your card each month, the less interest you’ll have to pay on the money you borrow. The best way to avoid costly interest payments is by paying your balance in full each month. If paying your balance in full simply isn’t an option, the next best thing you can do is pay as much toward your balance as possible. Just know that the more money you put towards an outstanding balance, the less interest you’ll have to pay in the long term.
Monitor Your Credit Card for Fraudulent Charges
Fraudulent charges can quickly rack up alarming amounts of debt on your credit card. By consistently monitoring the activity on your cards, you’ll be able to identify fraudulent transactions more quickly. Today, many cards offer alerts if suspect fraudulent activity is detected on your account.
Also, keep an eye out for a credit card that offers liability against fraudulent charges. This means that you won’t be responsible for paying any credit card charges that you didn’t authorize.
Store the Card for an Emergency
The age of your oldest credit card account is factored into your credit score, so keeping an open account could help you build credit in the long run. By storing your card for emergencies only, you’ll always have at least one account open. Keep in mind however, that some credit card companies may close your card if you don’t use it after a period of time, so it may be while to periodically use your card to make a small purchase to keep it active.
Other Times to Use Credit
While you should primarily use credit cards as a credit-building tool, there are other times when it can be a good idea to use credit, like paying off debts or financing large purchases you can’t afford to pay in cash. However, this is only recommended if you have a credit card with a very low Annual Percentage Rate (APR) – close to or equal to 0%. Higher interest rates/APRs mean higher borrowing costs, and you want to keep as much of your money for yourself as you can.
If you have a good credit score, financial institutions may offer you cards that have introductory 0% APR promotions; essentially, for a given number of months (usually 6 to 18), you won’t be responsible for making interest payments on any of the money you spend on the card.
There are two strategic ways you can make the most of this deal:
- If you qualify, transfer existing debts into the 0% APR account and pay them off (aka balance transfer)
- Break a major purchase into smaller, more manageable payments that you’ll pay in full over the introductory APR period
An Important Note on Rewards Programs
Many credit card companies offer rewards in the form of cashback, discounts on purchases, and free airline miles to entice consumers to use their cards. Earning rewards with a credit card can be a good reason to use your credit, but only on one, very strict condition: you can pay your balance in full each month. Why?
Cashback rates generally range anywhere from 1-5%, while average APRs hover around 15%. If you’re carrying a balance on your card but keep spending to earn rewards, understand that you’ll be paying much more in interest than you could ever earn in cashback.
When Not to Use Your Credit
You may have heard the advice: “Use your Credit Card as a Debit Card,” and that’s solid advice to start, Credit cards are a convenient, accessible payment method that can help you build credit, but their convenience can prove risky to users who don’t carefully consider how purchases fit into their budget. Using credit irresponsibly can quickly put a borrower into credit card debt, which could negatively impact their credit scores and other aspects of their financial health. Here are a few examples of situations where you should avoid using your credit card.
Consistent Spending Out of Budget
Using credit cards to pay for purchases you can’t afford to make in cash is a dangerous habit if you don’t follow a budget or have a detailed repayment plan. Continuously carrying large revolving balances on high-interest credit cards could lead to interest payments that cause you to spiral deep into debt before you know it.
Making Large Purchases Without a Repayment Plan
Having a repayment plan is essential, especially if you’re making purchases you can’t afford to pay in cash. Without considering how to pay off outstanding balances and implementing a spending limit, your risk of falling into additional debt is high. Make sure you’re setting aside an amount each month to make a significant payment toward your balance.
When the Balance is Close to the Credit Limit
Making purchases on a credit card when the balance is close to the credit limit can be risky. Not only could this raise your credit utilization to a level that harms your credit score, but you could also hit your credit card limit. This could result in a declined transaction or an overlimit fee. Keeping your balance high could also be placing yourself at risk to be denied future credit.
To Earn Rewards While You Have a Revolving Balance
Cashback, free airline miles, and discounts on purchases are great incentives, but if you have a revolving balance on a card and continue using it to collect rewards points, the amount of cashback you’ll receive will pale in comparison to the interest payments you’ll have to make. Simply put, you’re accumulating debt with very little return on the money you spend.
Large Impulse Purchases
Large impulse purchases could put you in jeopardy of acquiring large amounts of credit card debt, which could lead to a decreased credit score.
Pro-tip: If you know you struggle with self-control when it comes to spending, try implementing a “sleep on it” rule before making any major purchases. By giving yourself at least 24 hours to consider whether you really need an item or if it’s simply a fleeting want, you can cut back on impulse spending significantly.
KNOW THE POTENTIAL PITFALLS, BUT GO FORTH WITH A CREDIT CARD
Don’t let the scenarios above spook you away from the potential benefits of a credit card. There are a lot of benefits to using a credit card responsibly. As long as you know what not to do, you can quickly take advantage of the rewards, flexibility, credit building, and access that a credit card might offer to you.