We have Missy, credit underwriter, weighing in on the truth behind using credit cards to establish and build credit.
Credit Cards. Extremely useful tool towards building great credit? Or a plastic minion that ties your soul directly to the devil?
Something that I wish I were told when I got my first credit card…
DON’T APPLY FOR ONE IF YOU NEED ONE.
Let me clarify the word “need”. If your bills (rent, utilities, food, etc…) total $1000 a month and you make $1200 a month, applying for a credit card to help supplement your income is a big “no no” and will only cause you more grief in the long run. Even for the most genuine of intentions, this isn’t a wise idea.
In the most basic situations, next month when you need to pay your credit card bill, you may likely pay the minimum payment (which is usually very low, as little as $10) because you will figure out, quickly, that you still have your regular bills alongside this credit card bill, and $10 is all you can comfortably afford. This pattern will likely keep repeating each month. Even if you have not charged anything else, you will eventually pay off what you originally charged plus interest (which can easily be 29.99% of the balance). That $3.00 box of Frosted Flakes just turned into $10.00.
Remember, every purchase with a credit card is similar to signing a loan contract for that item.
Second, I would be remiss if I didn’t address one of the most common reasons that people apply for credit cards— to build credit. Coming from a loan underwriter’s perspective, this statement makes me cringe.
People often have great intention, but a credit card usually isn’t the correct tool. Credit cards are “revolving debt” which means the limit is available month to month for as long as the card is open, unlike an auto-loan where your loan amount eventually reaches $0, and the loan is closed. This can be intimidating if you have no credit, because it’s not uncommon to see credit as “extra money”, which it is not.
If you are a brand new to credit, you have likely heard the horror stories, but do not realize the full ramifications of using a credit card. While it can build your credit, it can also damage it.
Let’s go over some of the things that make up your credit score.
For clarification, your credit score is directly created and affected by the contents of your credit report.
1. According to Balance Track (LINK) the balance on your card in relation to its limit (30% is the threshold) affects your score.
Example: If your limit is $1000 and you have $301+ owed on your card that you will not be paying off by the end of the same month, your credit score will decrease.
2. As a new borrower, you know that you need to repay this debt. However, if you don’t pay it on time, this late payment will show on your credit report.
According to Balance Track, this is the biggest factor in calculating your credit score—35% of the equation, to be exact. Your late payments will also stay on your credit report for years, regardless if your credit card is open or closed.
3. Alright, so you have opened one card, so why not open a couple more…because that will build your credit score faster, right? Unfortunately many believe this myth more often than you’d think.
Balance Track states that the length of time your accounts (lines of credit/loans) have been open counts towards 10% of your credit score. This means opening too many credit lines too soon will result in a decrease in your score. But good news, this also means that having lines of credit open for a longer period of time will increase your score. In general, it takes 6 months (starting from a zero score with no collection items) to generate a credit score.
This is a lot to keep up with for even a small credit card, is it even worth the hassle to have a one?
It is definitely worth it!
Credit cards allow you to pay for unplanned emergencies, and give you a line of credit to use at your leisure. Their fraud protection is often stronger than debit cards—which is an invaluable benefit for traveling and online shopping. Credit cards also utilize reward programs for use (cash back, free flights, free hotels, etc.), free extended warranties on items bought with the card, free car rental insurance, and many other advantages.
If you follow the steps listed above, make a budget (“Man Vs Cash” does have a topic on that, found HERE!), do your research, and swipe responsibly, you’ll be on your way to becoming a “high-credit-having, credit-card-toting” hot shot.
Just remember: credit cards are not additional income, they are lines of CREDIT that must be paid back, with interest.
This article was contributed by Missy S., full time credit underwriter with 12+ years of experience in finance. A mother to an 11 year old boy, and a 12 year old girl, and a 3 month old Jack Russell. In the fleeting moments of silence she gets, she likes to go running, catch up on Madam Secretary and Scandal, and hang with good friends.