How Credit Card Builds Your Credit Score
If you're looking to make a major purchase without the high-interest rate, it's time for a credit score boost. A good credit score opens the door to low-interest lending, better auto loans, and more. A quick way to get this boost is with a credit card. Credit cards improve your credit score in a multitude of ways. Read on to find out how.
Credit Cards Help You Establish Credit History
All three credit bureaus gather information about your spending habits and creditworthiness to establish a credit score. A credit card offers you the ability to establish this history. When you pay on time, you're rewarded with an increase in points on your credit score. When you don't pay on time, you lose points. No one knows the exact formula credit bureaus use to calculate a score. What is known is that the following items are considered in creating that score:
• Payment history
• Utilization
• The ratio of payment history to the number of open accounts
• Used credit vs. available credit
• Type of credit usedHard inquiries (Anytime you apply for a credit card using your full social security number, that company requests information from the credit bureaus to verify your application and check your score – this is a hard inquiry.)
Low Credit Utilization is Rewarded with Credit Score Increases
The fastest way to establish a good credit score is to show good utilization. Credit utilization is the amount of credit used from your credit limit. There are two utilization factors on your credit report, and both factor into your score. One is the ratio of overall credit spent from your total available credit limit.
The second is the utilization ratio of the credit spent from one single credit card.
Spending too much of your credit (more than 30%) displays risky spending behavior. Banks and finance companies consider this information when deciding to lend to you. It also affects how much they'll lend. Consistently low credit utilization is rewarded with frequent score increases. The opposite is true for consistently high credit utilization.
Inheriting Good Credit Provides a Score Boost
Yes. You CAN inherit a good credit score. Major credit card companies and some store cards offer an Authorized User option to their clients. This allows them to add an individual to their account. If someone adds you as an Authorized User, you will receive your own separate credit card with either the same credit limit or an adjusted one.
So how does this increase your credit score?
You inherit the account holder's payment history, credit age, and credit limit. Someone with a $10,000 credit limit and a stellar payment history over ten years can add significant points to your score. However, a person with poor payment history or a young account could cause your score to sink. The key is ensuring the person adding you hasn't missed a single payment.
By now, you may be wondering if an account holder can add you to more than one account? The answer is yes. Not only can you be added to more than one account, but you could also be added to more than one person's account as an Authorized User. This is a great way to establish a credit history if your score is too low to qualify for a starter credit card.
On-Time Payments Boost Your Credit Score
One major factor in boosting your credit score is paying your credit card on time – but there is a caveat. If you pay your card to a $0 balance before your credit card company creates your monthly statement, it will report zero utilization to each of the three major credit bureaus. This results in a stale score (aka one that doesn't move much).
The key is to keep your utilization above zero but under 10% and pay this amount once your statement arrives.
Note: Although 1% to 10% is the best credit card utilization ratio, anything under 30% is ideal.
Good Payment History Yields More Card Offers
According to Experian, adding an additional credit card can boost your score by reducing your utilization. However, they warn that you may notice an immediate decrease in your score after applying for a card. The older your credit history is, the better your score. When you apply for a new card, it reduces the age of your credit overall. Therefore, the score slightly decreases when you apply for the new card. But not to worry, this decrease is temporary and will rebound with good payment history and consistently low utilization.
Credit Cards Build Business Credit Too
Some major lenders offer credit cards for business owners. These cards have much higher credit limits than personal credit cards. If your business is new or lacks revolving accounts, a business credit card is just what you need to help establish history. However, this process could take a few months. If you're in a pinch and you have a stack of unpaid invoices, invoice factoring from a factoring company could help.
An invoice factoring company purchases your business's invoices – allowing you to make emergency purchases or payments without waiting for your customers to pay up. In some cases, waiting could affect your ability to pay back personal and business credit cards, ultimately tanking both scores. If your business is struggling financially, look into invoice factoring as a solution to keep your credit card payments on track.
Conclusion
As you can see, credit cards – when used responsibly – boost your credit score from many different angles. As long as you maintain a low balance, pay on time, and maintain an increasing age, you'll enjoy the benefits of a low-interest lifestyle. The critical thing to remember here is that late payments tank your score, so ensure all payments are received on time.
If you own a business, this could prove difficult – especially if your customers' invoices are outstanding. Invoice factoring from a reputable factoring company is always an option to avoid late credit card payments.
What credit score are you aiming for? Would you use a credit card to build your credit score? Leave your comments below — we would love to see what you think.
