A credit card can be a powerful tool when used wisely, offering benefits like rewards, purchase protection, and building credit. However, misuse can lead to high fees and interest expense, poor spending habits, and a negative impact on your credit score.
Here are the top 5 best habits you should develop to make the most of your credit cards while avoiding the pitfalls.
1. Pay Your Balance in Full Every Month
One of the most important habits when using a credit card is to try and pay your balance in full each month. The credit card company doesn’t charge you interest when you pay your entire statement balance each month. In effect, you can get a one-month interest-free loan from your card company if you pay the statement balance each month.
If you do not pay the entire balance each month, interest charges accumulate on the balance carried forward to the next billing cycle. Credit card interest charges can rack up quickly, given the high Annual Percentage Rate (APR) attached to most cards. Many credit cards have interest rates ranging from 15% to 35%, so not paying your balance in full can become quite costly.
Paying the statement balance in full will also keep your credit utilization ratio low, positively impacting your credit score.
2. Keep Your Credit Card Utilization Low
Credit utilization refers to the amount of credit you use compared to your total available credit limit. Keeping this ratio low is crucial for maintaining a good credit score.
For example, assume you have three credit cards. The available credit limits on the three cards are $2,000, $3,000, and $5,000. The total available credit to you across all your credit cards is $10,000. Assume you only use the card with the $2,000 limit and have a current balance of $500. The remaining two credit cards have a zero balance.
Your credit utilization on the one credit card is 25% (i.e., $500 / $2,000). However, your overall credit utilization across all cards is only 5% (i.e., $500 / $10,000). Keeping this overall credit utilization low will improve your credit score. Credit scoring models, such as your FICO Score, consider a low utilization ratio a sign of responsible credit management. Most experts recommend that your overall utilization should be below 30%, but ideally zero is the best number.
3. Use Rewards Cards Strategically
Many credit cards offer rewards such as cashback, points, airline miles, or discounted rates on certain goods and services. However, to get the most value from rewards cards, it’s essential to use them strategically.
Choose a card that aligns with your spending habits. For example, if you spend a lot on groceries and dining out, a card offering bonus points or higher cashback rates in those categories makes sense.
Many cards offer substantial rewards for frequent travelers. However, if you travel infrequently, enrolling in a program offering extra points for hotels, plane tickets, or rental cars does not make sense because you’ll never incur those charges.
A key warning message to most users is that you should avoid spending more than you usually would to earn rewards, as the interest expense on a carried balance can quickly negate any benefit you receive from additional points or miles.
4. Monitor Your Credit Card Account Regularly
One of the best habits you can adopt is regularly monitoring your credit card activity. With the rise of online banking and mobile apps, checking your transactions in real-time is very easy, and setting up transaction alerts is relatively straightforward.
One recommended approach is downloading the credit card company’s App on your mobile device. You can set push notifications anytime a charge is applied to the card. This helps as a reminder for any recurring monthly charges you may have, as well as provide notification if your card was compromised.
If your card was compromised and someone used your card for fraudulent charges, you would receive a push notification for the transaction and immediately recognize it was not your transaction. Early detection of fraud allows you to report it to your credit card issuer and avoid responsibility for the charges.
Additionally, set up alerts to notify you of large purchases, due dates, or when your balance approaches a certain limit. This can help you stay on top of your spending and avoid late payments. You can have your credit card company send a weekly update on the current balance and when the payment is due.
5. Avoid Applying for Too Many Cards at Once
While it may be tempting to sign up for multiple credit cards to take advantage of rewards or sign-up bonuses, applying for too many cards can hurt your credit score. When you apply for new credit, whether that is a credit card, personal loan, auto loan, etc., an inquiry is placed on your credit report.
An inquiry can temporarily lower your score, and too many inquiries in a short period can signal desperation for credit, which can also reduce your credit score. To avoid this problem, it’s recommended that you space out credit applications over several months to avoid too many hard inquiries in a short period.
Having a longer credit history benefits your credit score, so it’s better to hold on to older credit cards rather than frequently opening and closing new ones. Although it may be tempting to close a credit card you are no longer using, it may be best to keep it open and put it away in the drawer for emergency use only. Having the card open with a zero balance each month will help your credit utilization and improve your credit score.
For example, assume you opened your first credit card when you were 18. You are now 25 and just opened a new travel rewards credit card with a different company. You plan only to use this new credit card, so you’re contemplating canceling your first card. It is recommended NOT to cancel the first credit card because you have seven years of good credit history with this account. You are better suited not to cancel the card and just leave it at home and not use it.
Conclusion
Using credit cards responsibly can unlock many great benefits, such as rewards, access to premium services, and improving your credit score. By following these recommended habits, you can get the most out of your credit cards without falling into debt or damaging your credit.