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We’ve talked previously about how debt can be good if you use it appropriately, and probably one of the best examples of this is the use of credit cards. Credit cards offer a ton of advantages, including great rewards and cashbacks, but in this post, I wanted to concentrate on the best reason to keep a credit card; to increase your credit score.
Your credit score is based on your credit behaviour and history, which means you must have a history of taking on debt in order to build it. Young people starting off on their financial journeys are probably not taking out auto loans or mortgages, so credit cards are the easiest way to build up your credit score.
If you want to learn more about credit scores in a Canadian context, I suggest reading this book. But if you just want some quick and dirty tips on using credit cards to advance your credit score, keep reading!
Part 1: Credit payments
Tip 1: Always pay your balance in full. Using credit cards is good but getting into credit card debt is very bad. Your credit card statements will show a Minimum Payment amount, but you should always be paying the full balance. Any unpaid balances on your credit card will not only incur outrageous amounts of interest but will also hurt your credit score.
Tip 2: Always pay your balance on time. Timely payments show qualities of a responsible payee who will pay any loans they have in the future on time. If you miss a credit card payment, your credit score will dramatically decrease. To avoid making credit payments, I recommend:
- Never spending more than you have in cash (you can use a budget app for this), and
- Setting up pre-authorized debit payments on each of your credit cards which will automatically draw money from your bank account, so you don’t accidentally forget to pay
Part 2: Credit utilization
Tip 3: Spend less than 30% of each credit card’s available credit. Your credit utilization rate is a very important factor going into the calculation of your credit score. If you’re using more than 30% of your available credit, you’re seen to be spending too much beyond your means, which will lower your credit score. I suggest periodically checking each of your credit card usages and rotating among them so that you’re maximizing your credit card benefits while not over-using them.
Tip 4: Maximize your total available credit. Another way to keep your overall credit utilization rate below 30% is to increase your total available credit. Whenever I get a pay bump, the first thing I do is apply to increase the credit limits on my credit cards. The higher these limits are, the more money you can spend on credit cards before hitting that 30%.
Part 3: Credit accounts
Tip 5: Always keep your first credit card open. Length of credit history is another factor that goes into the calculation of credit scores, and the start of your credit history is determined by the start of your first line of credit. By closing your first credit card, you’re shortening the length of your credit history, which will damage your credit score. Since most people’s first credit cards are free (i.e. no annual fees), there’s no harm in keeping it open even if you’re not planning on using it. Some options for free starter credit cards are TD’s Cash Back Visa and BMO’s Cash Back Mastercard.
Tip 6: Open credit cards but do so cautiously. Opening a new line of credit will also increase your total available credit but will require a credit inquiry by the credit card company you’re applying to. Credit inquiries will take a few points off your credit score, but it’s only temporary so your score should recover in less than a year. Therefore, while it’s good to open new credit cards (especially if there are ones with good benefits and low annual fees), it’s not advisable to overdo this, or to open any new cards around the same time as when you’re applying for another credit product like a mortgage, when you want your credit score to be maximized to get the best rates.
Tip 7: Avoid closing credit accounts if they’re free. I’ve probably already beaten this point to death, but you want to maximize your available credit whenever possible. Therefore, the idea is to open accounts and increase limits on existing accounts, not close accounts. Sometimes, if you’re not using the card enough to justify the annual fee on it, it does make sense to close the account, but if you’re considering closing a free credit account, just don’t do it. Today’s debt-ridden culture has scared some people away from using credit cards at all, but as the above tips show, if you use a credit card responsibly, it is the best tool in your belt to help your credit score.