Many people wonder about the relationship between credit cards and credit scores. While credit cards can be great tools in enabling you to purchase goods and services without having the cash on hand, they can also present an almost irresistible temptation to spend money you don’t have and mess up your credit score. What you might not realize is that credit cards can be your secret weapon in obtaining an excellent credit score. By understanding the impact your credit cards have on your credit score, you can take charge of your credit cards and leverage this knowledge into a higher credit score.
Credit cards and credit scores go hand-in-hand in several ways. First, take a look at the number of credit cards you own. Credit-scoring bureaus reward consumers the most if they can manage to responsibly balance between three and five credit cards. (See post, “How Many Credit Cards Should I Have?”) Credit card companies want to see that you can manage more than one or two credit cards at the same time, so if you have only a couple of cards, you may get a boost by obtaining an extra card or two.
Warning, if you have more than five credit cards, you shouldn’t immediately cancel a bunch of cards. First, this may damage your credit score by reducing the average age of your credit accounts. The length of your credit accounts determines fifteen percent of your credit score, so closing two or three credit card accounts may cause your credit score to drop. Second, you may be able to maintain and increase your credit score even with more five credit cards if you can pay down your balances to as close to zero as possible on any credit cards you rarely use.
Another important part of understanding credit cards and credit scores is the utilization rate. To get the best credit card score, you should maintain a utilization rate of 30 percent or less. Your utilization rate is the ratio of your balances against your credit card limits, expressed as a percentage. Therefore, if you have $600 worth of debt and your credit limit stands at $1,000, your utilization rate is 60 percent. Credit-scoring companies will award you a higher credit score with a sub-30 percent utilization rate, so if you can pay down your debt below this threshold, you will likely see a quick boost to your score.
Another way to strengthen the relationship between your credit cards and credit scores is review your credit report. Make sure you are using the best credit monitoring practices to keep track of whether your credit limits have been accurately reported.
If your credit card company reports your limit as $2,000 instead of $4,000, the $1000 balance on your card goes from being an attractive utilization rate to a negative factor that will drag down your credit score. In other words, rather than showing a 25 percent utilization rate, your credit card will show a 50 percent utilization rate. Unfortunately, credit limits are frequently misreported, so this should a mandatory item for you to double-check when you are reviewing your credit report.
One of the advantages of keeping on top of your credit cards and credit scores is being able to save money. Once you’ve built your credit score by using your credit cards wisely, you can flex your financial muscles. Call your credit card companies, point to your steady and responsible behavior, and ask for a lower interest rate.