Credit cards can be a useful tool for consumers to build credit and increase their credit scores. On the flipside, they can be harmful when people rely on credit cards to pay for all their expenses and fail to pay down their credit card balance.
The impact of credit cards on your credit scores is high because it demonstrates your ability to manage and pay off debt to potential lenders and creditors. That's why making payments on time is the biggest factor in most credit scores and makes up 35% of your FICO® Score.
Additionally, how much credit you're using of your available credit is also important. This is known as your credit utilization rate—the percentage of credit used vs. credit available, based on your credit card limits.
What Is Revolving Credit?
Credit cards give consumers the option to carry their balance over each month which is otherwise known as "revolving" the balance.
Revolving credit is a type of debt generally associated with credit cards because as consumers pay down their balance each month, they are able to incur more charges. The credit limit is established by the lender and can increase or decrease depending on certain factors such as the payment history of the consumer.
The interest rate on revolving credits can fluctuate, which means the monthly payments could also rise.
Any balances which are carried over to the next month will be charged with interest, which adds to the initial principal amount. Annual fees and late payment fees are also charged by many credit card issuers.
How to Use Credit Cards to Build Credit
Consumers often use credit cards to finance purchases and establish a credit history. Lenders want to see a history of consumers paying their bills on time. One easy way to do this is by using a credit card for purchases that can be paid off, on time, in its entirety.
By using a credit card and paying it on time, you'll show potential lenders that you can successfully manage credit. It's best to pay your credit card off each month if possible to keep your credit utilization rate down. If that's not possible, then pay off as much as you can to avoid racking up interest charges and keep your credit utilization low.
How Credit Cards Affect Your Credit
Consumers, who primarily use their debit cards or haven't had a credit card before, need to establish or build their credit history, especially if they do not have any other debts such as student or auto loans. Charges made on a debit card are not counted towards a person's credit history, so they don't help your credit scores.
When consumers are seeking a large type of loan such as a mortgage to purchase a home, lenders usually want to see both revolving and installment credit. This demonstrates to lenders that you can balance all of your financial responsibilities.
Installment credit is the other type of credit consumers often use and are familiar with; these include student loans, mortgages and auto loans. Lenders will give consumers a loan for a set amount that you pay back monthly during a fixed period of time, such as a $20,000 car loan for six years.
A longer credit history and higher credit scores usually mean consumers will receive a lower interest rate for their loans. A lower interest rate results in individuals being able to pay down the principal faster and be debt-free sooner.
When Credit Cards Can Hurt Your Credit Scores
There is a tendency by people to use their credit cards when they are running low on savings or are recently unemployed. When they use too much of the credit made available to them, it can raise their credit utilization rate. For instance, if your credit limit is $3,000 and the balance is often $1,000 or higher, this can lower your credit scores.
When you have too many credit cards which all have high balances, your credit scores will also be affected. Missing a payment on your credit card is another factor which can lower your score.
Use your credit cards and your credit limit carefully as your budget and financial resources can shift as changes occur in your employment, housing or other lifestyle factors. If you can not pay your balance in full each month, make sure your monthly payments are made on time and try to pay more the minimum balance when you can. Credit cards can be a helpful way for you to build your credit scores and payment history.
Applying for New Credit Cards
When applying for new credit cards, it's a good idea to research different types of credit cards and determine what card might be best for you, based on your spending habits and current credit scores
For instance, if you travel a lot, a rewards credit card might be worth considering. Also, if you have low credit scores, you may not qualify for certain credit cards with lower interest rates, rewards, or cards without an annual fee.
One way to find a card that is a good fit is to check out Experian CreditMatch. If you sign up for a free account, you can use our credit card matching technology to analyze your individual credit situation, and get matched with cards you're more likely to qualify for and that make sense for you based on your spending habits. (You'll also get a free FICO® Score and Experian credit report when you sign up.)
Advantages of Credit Cards
Consumers can receive several credit cards which gives them the flexibility to use them whenever they need them. The best strategy is to pay off the debt in full each month.
Some credit cards offer rewards or cash back on purchases, so you can use your spending habits to get additional benefits if you use the cards prudently.
Credit cards are also good to use at gas stations, shopping online, or with retailers because they offer more fraud protection than debit cards. So if you're the victim of theft or fraud, you won't be on the hook for charges and it's easier to get it taken care of that with a debit card—where money may have already come out of your account before the fraud is determined.
Additionally, credit cards usually offer additional benefits like purchase protection or travel insurance. Check with your credit card issuer to see exactly what your card offers and consider these things before applying for a new credit card.
Editorial Disclaimer: Opinions expressed here are author's alone, not those of any bank, credit card issuer, or other company, and have not been reviewed, approved or otherwise endorsed by any of these entities. All information, including rates and fees, are accurate as of the date of publication.