July 6, 2023
Your credit score is a three-digit summary of your financial identity. The number reflects how well you’ve managed your money in the past and how trustworthy you might be in repaying future debt. The major credit-reporting agencies use a number of factors to calculate credit scores, but how you manage your revolving credit is a critical one. Exactly how credit cards affect your credit score depends on how you handle them — how you use them and how you pay back what you’ve borrowed.
How Important Is My Credit Score?
Credit bureaus like Experian, Equifax and TransUnion collect, track, and analyze financial data and generate credit reports for individuals upon request. A typical credit report for an individual lists personal identifying information, the details of credit accounts, collection items like liens or foreclosures, and previous credit report inquiries. Analysis focuses on your payment history, the amounts owed, the length of your history, the types of credit represented on the report and new credit activity.
Each credit bureau applies its own proprietary mathematical formula to the data they’ve collected to calculate a three-digit number typically between 300 and 850. This is why your credit score may differ slightly from bureau to bureau. For all, however, the greater the number, the better the credit score.
All sorts of financial institutions, businesses and organizations rely on credit scores to determine whether they want to establish a financial relationship with a particular individual. Banks, for example, will use your credit score to determine not only if they’ll give you a loan but also what terms will apply. Insurance companies will use your score to determine your premium. Landlords may use it to decide whether to issue you a lease. Potential employers may make or rescind a job offer based on your credit score, particularly if there is a financial responsibility associated with the role. Credit card issuers rely on credit scores to determine whether they’ll approve a new account. Then, how you use that account in turn influences your credit score in very specific ways.
What Is a Credit Card Utilization Ratio?
The credit card utilization ratio represents a significant percentage of data, nearly a third, that contributes to your credit score. Basically, it compares how much revolving credit is available to you versus how much you are actually borrowing.
For example, you may have a credit card that has a credit limit of $5,000. Carrying a balance of $4,000 for months or years is quite different from putting about $200 on it each month and paying off the balance each cycle. In the first case, the utilization rate would be 80 percent. In the second case, the utilization rate would be a mere four percent. Being selective about what you use your credit card for and limiting expenditures to a balance you can pay off each month can help to keep your utilization rate in an optimal range.
If you have multiple cards, calculations can also be cumulative or the total amount of debt versus the total amount of credit extended. If you have three cards with credit limits that total $20,000, for example, and you owe $5,000, you’ve utilized 25 percent. However, analysis often also examines the utilization ratio of each card as well. If you must make a large purchase, you may want to split the expenditure across two or even three cards.
Each time you buy something on credit, you are increasing your utilization ratio. Likewise, each time you make a payment on a credit card or line of credit, you are decreasing your utilization ratio. So, knowing each card’s limit is vital to maintaining healthy utilization percentages on individual cards as well as cumulative totals.
Opening or closing a credit account will also affect your overall credit utilization ratio. Opening an account will increase your cumulative limit. Closing an account will decrease your cumulative limit.
Using your credit is important because it helps to establish a steady pattern of borrowing and repaying. Responsible use keeps accounts active and can result in credit limit increases over time, automatically improving your utilization ratio. Ideally, however, utilization rates should not exceed 30 percent, and lower utilization ratios are more advantageous for your credit score.
How Does Repayment History Affect My Credit Score?
Credit bureaus view your repayment history as a way of evaluating how you have handled financial responsibilities in the past. The assumption is that your past actions predict future ones. Typically, your repayment history will include any major credit cards, retail store credit cards or lines of credit, finance company accounts, and installment loans like a car loan or mortgage.
Credit bureaus look at whether you’ve paid your bills on time when analyzing your repayment history. If the history shows late or delinquent payments, the analysis will look at how often those occur. If you’ve had issues like a bankruptcy, delinquency, a lawsuit, judgment or debt that has gone to collections, the timeframe of the event and your repayment history since then also become part of the credit score calculation.
Since repayment history can represent a third or more of the data used to calculate your credit score, paying bills on time is crucial to maintaining a favorable credit score. Following these simple strategies can help:
- Organize a budget that includes all of your financial responsibilities so that nothing is overlooked or forgotten.
- Coordinate billing cycles with your income. Having some bills come due early in the month and others later may allow for better cash flow and allocation of funds. Many creditors will let you choose or change your due dates.
- Review all bills and statements carefully to ensure all charges are accurate.
- Use online alerts and reminders.
- Set aside a regular time and place to pay bills and schedule online payments. Most creditors allow you to schedule drafts well in advance of the due date, but the money won’t leave your account until the date you’ve selected.
Even if being late on a payment isn’t a concern, know the grace periods on your accounts just in case. If you have accounts that are overdue, work with creditors to bring them up to date.
How Does Applying for Credit and Hard Inquiries Affect My Score?
Credit inquiries happen any time someone accesses your credit report. The use of soft inquiries or soft pulls versus hard inquiries or hard pulls confuses many people. Both are ways of checking your credit, and both will appear on your credit report as an inquiry for two years. While a soft pull won’t impact your credit score, a hard pull or hard inquiry will.
Soft credit pulls are usually associated with non-borrowing situations like employers vetting candidates, insurance underwriters qualifying clients or companies screening for promotional offers. Only you will see that a soft pull was done. Lenders won’t.
As a rule, any time you apply to borrow money, the potential creditor will do a hard credit inquiry. For example, if you apply for a mortgage or a car loan, the lender will want to see your credit report before approving or rejecting your application. Those are loans secured by collateral like the home or car purchased. If you apply for a credit card, you’re asking for an unsecured line of credit or money you can use as you choose with no collateral. The credit card issuer will do a hard credit pull and that will be recorded on your credit report.
While hard inquiries represent only about 10 percent of the data used to calculate a credit score, they can cost points. A single credit card application and the resulting inquiry may deduct five points from your overall score. That number will likely bounce back and even increase with responsible card usage. Having multiple hard inquiries from various credit card issuers in a short period of time, however, can be more damaging because it shows an individual repeatedly applying for unsecured sums of revolving credit.
The best strategy is to have your financial affairs in order so that when you do apply for the credit card you want, you’ll be approved. The credit limit may seem low at first, but with responsible usage and repayment, you’ll be able to increase the credit available to you over time. If you'd like additional cards in the future, you'll want to be selective, be aware of other inquiries on your report and plan accordingly.
Does Credit Card Account Age Really Matter?
One of the hardest things about establishing a good credit record is having a history at all. Without a loan or credit card, you’re an unknown to a credit bureau. Inversely, the longer you’ve held an account, the greater the length of the credit history.
Credit bureaus look at the age of your oldest account that remains open and active as well as the newest accounts. They will also calculate an average age representing all of your accounts. This is another reason why closing accounts can be damaging to your credit score; especially if the account demonstrated longevity. You lose not only the sum of the available credit but also the length of the credit history.
Lengthening the age or history of your credit accounts entails being able to not only establish accounts but also keep them open. Follow these tips to ensure you maintain your credit history:
- Stick with credit cards with no annual fee. You’ll be less tempted to close accounts due to frustration with hefty yearly fees.
- Be sure to use the account to keep it active. Otherwise, issuers may close inactive accounts or reduce credit limits.
- Keep balances in check. If you must refinance or consolidate the credit card debt, you may also have to close the account.
- Recognize the value of that first credit card. It begins your credit history.
For individuals struggling with a lack of credit, alternative strategies like opening a secured credit card or credit-building loan can be helpful in demonstrating credit worthiness.
Secured credit cards typically require a deposit equal to your credit limit, but the credit card account basically functions like an unsecured one. You still have to make payments on purchases, and balances are subject to accumulating interest.
Credit-building loans are another option. Typically under $1,000, these loans deposit money in a savings account, but you don’t gain access to it until you’ve completed the repayment plan. Some plans will even pay out a portion of the interest charged as dividends. The whole point is in proving to lenders that you’ll repay what you borrow on time.
How Do I Check My Credit Score and Credit Report?
Everyone is entitled to one free full credit report from each of the three major credit reporting bureaus every 12 months. The Consumer Financial Protection Bureau recommends doing this through AnnualCreditReport.com. You can request reports from all three at once or space them out throughout the year one at a time. You may also be able to view updates to your report online for free.
You may be entitled to additional free reports if you meet certain criteria like being denied credit or suffer an “adverse action” based on your credit report, if you suspect fraud, if you are unemployed and planning to apply for employment, if you are on public welfare assistance or if your state laws provide for additional free reports.
When you receive your report, check every detail, and ensure that everything on the report actually belongs to you. Sometimes, errors can create mixed files due to similarities in names, nicknames or Social Security numbers, for example. If something appears on your report that you don’t recognize, even a soft inquiry, it can be cause for concern.
Most importantly, if you find errors in your report, you can dispute them for free. If you suspect that you have been the victim of identity theft, you can freeze your credit file to prevent any creditors from opening any new accounts in your name. Each of the major credit bureaus also offers their own version of a credit lock that allows you to permit access to a certain inquiry, for example, and then lock your file again so that no other creditors can access it.
Can I Build My Credit Score with a La Cap Credit Card?
In today’s world, you need a positive credit history to create the life you want to live. The sooner you start it, the better, and a good credit card can help. It's the positive side of how credit cards affect your credit score. At La Capitol Federal Credit Union, we offer three different credit cards with low introductory rates, low interest rates and even rewards for using them. Check them out, and choose the one that’s right for you.