How to Use a Credit Card to Build Credit

How to Use a Credit Card to Build Credit

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Purposeful and responsible credit card use is an excellent way to build credit.

FICO and VantageScore are the two primary credit scoring models. Both models show that payment history is the most significant single factor in credit scoring. 

Keep this in mind as you begin using your cards to build your credit score.

Credit Cards That Can Help You Build Credit

Secured Credit Cards

Lenders extend credit in the form of secured or unsecured debt. With secured debt, the lender maintains something of value that represents the collateral. With a car loan, the lender will reclaim or repossess the vehicle if a borrower defaults on the agreement.

With a secured credit card, the lender uses a security deposit as a form of protection or collateral. Here, the borrower must provide a cash deposit upon opening the account, usually in the $200 to $500 range, which is an amount equal to the card’s credit limit.

Secured credit cards are often used by borrowers who lack a credit history or have poor credit. Responsible borrowers will make purchases and repay the balances on time each month. 

This plan is an effective way of building a credit history. With responsible use and time, cardholders often soon qualify for an unsecured credit card.

Student Credit Cards 

Most credit card issuers today offer accounts for college students. To qualify, applicants must usually provide evidence confirming their enrollment. Examples may include a student ID, transcript, or other documentation from the school. 

Unlike secured credit cards, these are usually unsecured accounts, making them more appealing. Capital One currently has three different types of student credit cards. They all have no annual fees and offer rewards.

The cards report to all three major credit bureaus: Experian, Equifax, and TransUnion. As with most student credit cards, the interest rates are high, ranging from roughly 19% to 29%. 

Thus, those using these cards to build credit should pay all or the majority of their balance off each month. 

Becoming an Authorized User on Someone Else’s Card

Another way of boosting your credit score involves asking a friend or relative to add you as an authorized user on their credit card. As an authorized user, you become eligible for making purchases using the card.

An authorized user is a secondary user that assumes no responsibility for payments. Yet, most card issuers report authorized users to the credit bureaus.

Most authorized users usually recognize a small, positive impact on their credit score.  Traditionally, cardholders added spouses or children as authorized users on their accounts. Often, this process is described as “piggybacking.”

Keep in mind that this strategy could backfire. For example, if the primary cardholder begins making late payments.  

What To Do After Getting Your Credit Card

Use Your Credit Card

After qualifying for a secured credit card or student credit card, you can begin to build credit with it. Use the card in retail stores or online for purchasing different types of products or services. 

Avoid the temptation to begin spending frivolously on items that you cannot afford. Excessive credit card spending remains among the leading causes of financial problems.

Thus, avoid irresponsible spending on items you otherwise could not afford without it. Your credit card should not become a substitute for saving money in case of emergencies.

One way of ensuring that you continually use the card each month involves recurring automatic payments. For example, using the card for an inexpensive monthly streaming subscription.

Be sure to keep your card utilization under 30%, but 10% is even better.

Pay Your Bill on Time

Consumers seeking to improve their credit using a credit card should not lose sight of that goal.  The priority or main purpose of using the card is to establish a good payment history.

Both the FICO and VantageScore models rank payment history as a critical factor. Payment history is influential, equating to roughly 35% of your FICO 8 Scores and 41% of your VantageScore 4.0.

Always ensure that you make no less than the minimum monthly payment before the due date each month. Having late payments will significantly hinder your efforts of building credit.

According to Equifax, late payments typically appear on your credit history if they are 30 days past due. To make matters worse, most credit card accounts also impose late fees.

Maintain a Low Utilization Rate

Another consideration when building credit while using credit cards involves your credit utilization rate. Your utilization rate is a metric that applies to revolving credit accounts.

The two primary types of revolving credit accounts are credit cards and personal credit lines. For the purposes of building credit, consumers should use their cards each month. Yet, avoid having account balances that approach the credit limit.

Both credit scoring models perform a basic calculation that assesses your utilization ratio. Having a $990 balance on a credit card with a $1,000 credit limit is a “red flag.”

Using this example, the consumer has a 99% utilization rate. Data shows that borrowers are often experiencing financial problems when credit cards are nearly “maxed out.”

A good credit utilization rate is below 30%. An excellent credit utilization rate is below 10%. If you have two or more credit cards, the calculation applies to the sums of all balances and credit limits. 

Treat it Like a Debit Card

Issued by a bank, debit cards combine the features of an ATM card and a credit card. Usually bearing a Visa or Mastercard logo, debit card purchases use funds from bank accounts.

Unlike credit cards, debit cards are not used for financing purchases. What is “treating” your credit card like a debit card? Here, the concept is to use the card responsibly.

With a credit card, a consumer makes a purchase using borrowed funds. When using a credit card for building credit, only purchase items you can afford.

Operate with the intention of paying all or the majority of the balance off each month. Otherwise, you begin accruing interest on any remaining balance.

Keep Your Accounts Open

Often, consumers should keep a credit card account open–even if rarely used. This concept applies to several factors that determine your credit score.

FICO 8 Score Breakdown

Payment History 35%
Amounts Owed (includes credit utilization rate) 30%
Length of Credit History15%
New Credit Accounts10%
Credit Mix10%

Source: FICO 

Closing a credit card account might negatively affect three of the categories outlined. Closing a credit card account may cause your credit utilization rate to surge. This results from reducing your overall total credit limit on revolving accounts.

Closing an account might reduce your length of credit history. This is of particular importance if the account closed was the oldest on your credit history.

Closing an account might also hinder your credit mix. Especially if the closed account is the only revolving account in your credit history.

Can You Build Credit Without a Credit Card?

Yes. Consumers have a variety of options for building credit beyond only credit cards. Consider some of the following alternatives:

  • A credit builder loan: A variation of an installment loan, credit builder loans feature a fixed monthly payment. Often with a term of 12 to 36 months, they allow for creating a solid payment history.
  • Student loans: Those pursuing a college education can also build credit with a student loan. Payments on these installment loans are usually deferred until after graduation.
  • Car loans: Are you in need of dependable transportation? Car loans usually allow for building a multi-year payment history.
  • Rent or utility reporting:  All three credit bureaus will include rent payments in your credit history. Many of these services also report utility bills and other regular monthly expenses.

Secured credit cards and student credit cards are possible options for building credit. Usually, consumers lacking any credit history or with bad credit will qualify.

Credit cards also can positively impact most of the factors used in the FICO and VantageScore models. Keep in mind that credit cards are only one of many credit-building options.

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