How Credit Cards Affect Your Credit Score
If you have one credit card or even four or more credit cards, then you are not an outlier. In fact, according to creditcard.com, "multiple studies say about 7 in 10 Americans have at least one credit card". On the downside, over half of Americans who report having at least one credit card also report having debt. Because of this, it is no surprise that if you have a credit card or are considering getting a credit card, you might be concerned with how credit cards affect your credit score.
Credit Cards’ Impact on Your Credit Score
There are five main factors that affect your credit score. First, we will analyze how credit cards affect your credit score according to these five factors. Then we will analyze how credit cards affect your credit score over the credit card life cycle - that is, from opening your credit card through using your credit card for purchases to finally closing your credit card. After this, we will analyze how not having any credit cards - or even having too many credit cards - affects your credit score. And finally, we will go over the credit score and credit card basics. So, let’s start!
Before all of this, let’s take a look at different credit card options that are out there, so that you can choose which one works best for you:
How Credit Cards Affect the Five Credit Score Factors
By analyzing the five factors above, you can determine how credit cards affect your credit score. We will go through each factor and how it relates to the question of how credit cards affect your credit score.
Payment History
Having a payment history of paying off the balance of your credit card on time every month will positively impact your credit score, while consistently making late payments - or not paying at all - will negatively impact your credit score.
Credit Utilization
Using the credit available to you in a responsible way will positively impact your credit score while using too much of your credit or none of it at all will negatively impact your credit score. Not utilizing any credit could indicate that you do not have enough money to spend or pay off debt.
Credit History
Having credit card accounts that have been open for a long period of time and showing that you have a healthy relationship with that account will positively impact your credit score, while opening and closing credit card accounts all of the time will negatively impact your credit score.
Credit Mix
Having a good mix of credit will positively impact your credit score while having fewer and less diverse accounts will negatively impact your credit score.
New Credit
Opening a new credit card account can positively impact your credit score while opening too many credit accounts can negatively impact your credit score, as it may show financial instability.
Though each factor is weighted differently, each is important in determining how credit cards affect your credit score.
How Opening a Credit Card Affects Your Credit Score
Before using your credit card for the first time, your credit score can be affected. Even just opening a credit card affects your credit score. Here are some of the ways in which just opening a credit card affects your credit score. You won't be surprised to see a few of the credit score factors from above mentioned here.
Hard Inquiries
When you apply for a credit card or apply for credit of any kind, a credit background check is usually conducted. This credit background check is called a hard inquiry. (On the other hand, a soft inquiry is done if you check your credit or are prequalified for special credit offers.) Even though a hard inquiry is done to see how your credit is, a hard inquiry does itself negatively impact your credit. This hard inquiry will show up on your credit file -- so other credit companies can see it if you are requesting credit from many places in a short period of time -- and will negatively impact your credit score. It only drops you a few points for a few months, but the hard inquiry can still last on your credit file for a couple of years.
Credit mix
We mentioned before that having a mix of types of credit is good and will positively impact your credit score. Well, your credit score can be positively impacted before you even use your credit score because once you open your new credit card, you already increase the types of credit you hold -- if you mostly hold other types of credit at the time.
Credit History
Credit history is about credit over time. Obviously if you only just now opened your credit card, you have only held the credit for a very short amount of time. Because opening a new credit card will decrease your average age of accounts, your credit score will be negatively impacted.
Credit Utilization
While a decrease in credit history is not seen as a positive thing, it is seen as a positive thing to have more credit available to you that you are using in a responsible way. Increasing your credit limit by opening a new credit card can decrease your credit utilization -- basically by decreasing the percentage you use from the total amount of credit available to you, which in turn will positively impact your credit score.
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How Using Your Credit Cards Affects Your Credit Score
This is a lot like what we talked about before, when going through the credit score factors. If you use your credit cards responsibly -- paying your balance, or minimum payment, on time every time -- then your credit score will be positively impacted.
Opening a credit card can positively impact your credit score because of the increase in credit mix and decrease in credit utilization, but you can achieve similar results in your credit score by proving over time that you handle money responsibly. This will particularly become visible in your payment history and credit utilization, and over a longer period it will become visible via your credit history.
How Closing a Credit Card Affects Your Credit Score
Now for the death phase of the credit card life cycle: closing your credit card. If closing your credit card is the best option for you, then do it. Don't worry about how it might slightly affect your credit score. However, if you do not have to close your credit card but are just considering it, then consider these ways that closing a credit card can affect your credit score.
Credit Mix
Of course, if you are closing a line of credit, you will probably be decreasing the types of credit you hold. This can negatively impact your credit score.
Credit Utilization
Opening a credit card positively impacted your credit score, so closing a credit card will - logically - negatively impact your credit score.
On the other hand, if you are using your credit cards irresponsibly or cannot handle having too many of them, then do what is best for you. If your credit card is in the death phase of the credit card life cycle, then let it go: RIP.
How Not Having a Credit Card Affects Your Credit Score
Opening credit cards, using credit cards, and closing credit cards all affect your credit score. Well, surprise surprise, even not having a credit card can affect your credit score!
Credit Mix
Let's start with the easy one. If you don't have a credit card, which is in the category of revolving credit, then you will have a smaller credit mix than if you did have a credit card.
Credit History
If you have no credit, then you might be in trouble. Having no credit at all is as bad -- if not worse -- than having bad credit. Just think, if someone is doing a credit background check and finds nothing at all, then they will probably not want to offer you credit either. They have no way to show that you have a healthy relationship with money and will indeed pay them back.
How Having Too Many Credit Cards Affect Your Credit Score
Payment History
If you pay off all of your credit cards on time every time, then you can rack up a positive payment history. This will positively impact your credit score.
Credit Utilization
Technically, if you don't use too much of the credit you have, your credit score could reflect good credit utilization, which would positively impact your credit score. However, if you are getting a bunch of credit cards to rack up debt on that you don't pay off, this will negatively impact your credit utilization and credit score.
Credit Mix
We're gonna start with the easiest again. It's the easiest because: If you have too much of one type of credit, it will clearly throw off your credit mix. If you have too many credit cards, then it will negatively impact your credit score.
Credit History
Your credit cards will only positively impact your credit history -- and thus your credit score -- if you actually have and use your many credit cards over a longer period of time.
It's one thing if you are just opening one or two rewards credit cards for the benefits. Do not be discouraged from getting rewards cards that can benefit your lifestyle. Just be aware if you have too many credit cards. A good rule of thumb: If you have to search for a new wallet that will hold all of your credit cards, then you may have too many credit cards.
You may ask yourself: "Well, how many credit cards are too many?" Ultimately that is up to you. What's right for someone else may be different than what is right for you. Follow our guidelines, but make your own rules.
Credit Card Basics
Credit cards can be a great option for paying for a variety of things, but there are certainly some negative aspects of using credit cards. If you do not yet have a credit card, then you should consider these pros and cons before getting one.
Pros of Credit Cards
Flexibility
Not having to carry cash can be convenient, and sometimes it may feel safer to carry a card rather than large sums of cash. Using credit cards is also so easy, so it is no surprise that they have become so commonplace.
It is even easier now with the increase in digital technology. Many cards even have chips now, which make them more secure; these cards are called EMV cards. Even simpler: contactless payment cards, which allow you to pay by just holding your card over the card reading machine.
High-Limit Cards
While high-limit cards can come with a downside, at least when they are misused, they can also be very helpful. Just as they sound, high-limit credit cards are credit cards that carry high credit limits. This can allow you to use money that you may or may not actually currently have in your possession on a large purchase. While this is not encouraged for unnecessary expenses -- such as on a shopping spree -- or for just in general overspending, high-limit cards can come in handy when a big expense has come up and you would, for instance, rather not get a loan.
For instance, if your car breaks down or a necessary home appliance stops working, then using a high-limit credit card to pay for the repair can help ensure that you will not go over your limit. You should never rack up too high of a balance on your credit cards -- a balance larger than what you can pay off in full and on time is too high -- but a high-limit credit card may give you the buffer you need until your next payday or until you can find an alternative. Make sure you use a high-limit credit card consciously, with intent, rather than just whenever you want to purchase something large.
Financial Protection
Make sure you know the terms and conditions for your credit card(s), and if you are searching for a credit card, try to search for a credit card with good terms and conditions. For instance, some credit cards offer better policies regarding fraud protection or consumer assistance.
Trust me, it is better to have a better relationship with your credit company and to feel like they have your back, rather than dealing with issues all on your own when they come up. For instance, if you have an incorrect charge on your card, it is much better if you can dispute a charge and are able to reverse a charge, rather than having no fraud protection, losing that money, and having to fight tooth and nail to get your money back.
Better Organization
While you should still track your budget and balance your checkbook -- if you have one, using a credit card can make organizing your funds much easier. If you, for example, sometimes forget to record certain expenses -- like a few bucks for coffee at a coffee shop -- every once in a while when paying with cash, then hopefully it won't add up to too much. But if you forget to record these small expenses all the time -- and maybe even some larger ones, then you may not have a full picture of your financial situation.
When you use a credit card though, you don't have to track each expense yourself; rather, you can just log in to online banking and see how much you spent and where, as well as how much money you still have in your account. Using a credit card in conjunction with online banking can help you stay better organized in tracking your finances.
Earn Rewards
Many credit card companies have rewards cards. Some offer cash back, while some offer points or miles. These rewards can be a great incentive for choosing one credit card over another. For example, if you enjoy traveling, then you may consider looking into getting a travel credit card. Travel credit cards can help you earn your next trip, by earning points and miles on your regular, everyday expenses. Travel credit cards can come in the form of airline credit cards, hotel credit cards, or even regular credit cards that offer many benefits for traveling expenses.
This type of credit card may only be worth it for you if you really are someone who travels a lot though, since many rewards credit cards have high annual fees. Make sure you find a rewards card that is actually beneficial to you -- whether it is for travel, retail, gas, or even general reward points. Otherwise it will not be worth the annual fee. However, if you do find a rewards credit card that you can reap a lot of benefits from, then go for it! It's like free money! It is great to earn rewards based on money you would have already been spending anyway.
Build or Rebuild Your Credit
If you don't have credit or if you have bad credit, then getting a credit card could actually help you build or rebuild your credit. Don't fall into the trap though. You will only build your credit -- in a positive way -- if you pay off your credit card on time every time. It doesn't help you to spend way more money than you have and then not being able to pay off your monthly balance. The point is to build trust with creditors; the idea is that you are proving to creditors that you can be trusted to pay what you owe. If you do this over a period of time, then you can improve your credit.
Consolidate Your Debt
If you have considered debt consolidation, a method of eliminating debt by combining your debts into one payment, then you may want to use a credit card to consolidate your debt. One reason to consolidate your debt is to try to get a better interest rate on your debt, and this is one great reason to use a credit card to consolidate your debt -- if you are able to find a credit card with a better interest rate than what you currently have on your debt. However, credit cards can oftentimes have a higher interest rate than personal loans, so some people do the opposite: They will get a personal loan to consolidate their credit card debt. Determine which option is better for you after seeing what deals you can get for each option.
Cons of Credit Cards
Encouragement to Be Impulsive
Earlier we talked about how great it is that credit cards allow us so much flexibility. While this can be a blessing, it can also be a curse. This is because flexibility and ease can lead us to make impulsive decisions. Impulsivity isn't always bad. Sometimes it is good and fun to make last-minute decisions to meet up with friends, go to the movies, or eat out, but impulsivity with spending should be kept to a minimum; everything requires balance. Don't spend more money than you have to spend.
The Debt Cycle
Credit cards are literally designed to keep you in debt. This goes along with the point above. It is great to have flexibility in payment, but it is designed to be so easy and comfortable because credit card companies need to keep us around -- spending money, paying interest, and continuing in this cycle of debt. Use your credit card(s) responsibly, and avoid the debt cycle.
Minimum Payments
You may be encouraged to make the minimum payments on your credit card(s). I get it, who wants to spend all their extra money on debt? But don't fall for the minimum payment trap. If you always only pay the minimum payment, then you will never catch up, and you will continue paying more and more interest -- ultimately paying more than if you had paid off your balance quicker.
Interest Rates and Fees
Interest rates and fees can add up quickly. If possible, choose a credit card with a lower interest rate. Regardless, try not to use your credit card if you don't have to. If you must use your credit card, then do not spend more than your balance.
Credit Score Basics
Now that you know how credit cards work, you can finally begin to understand how credit cards affect your credit score. But first, you need to understand what a credit score is and what all affects this credit score.
What even is credit? According to Dictionary.com, credit is "the ability of a customer to obtain goods or services before payment, based on the trust that payment will be made in the future." When it comes down to it, the most important concept related to credit is trust. Everything comes back to this trust, trust of whether you will keep your word to pay what you owe.
Your credit score is just a three-digit number that represents this trust. While it is a common debate what is considered a good credit, the consensus is usually that a score between 700 and 749 is considered good, while a score between 650 and 699 is considered fair.
There are many online sites that can run your credit score for free. If you are interested in the bigger picture, you may ask yourself, "But how do I check my credit report?" Your credit report, which includes your credit score, will give you a lot more information about you, including your basic personal information, your address and past addresses, your contact information such as your phone number, your employment history, and your credit history.
You can go here for your credit scores and credit reports from all three bureaus -- Equifax, TransUnion, and Experian.
There are many things that can affect your credit, but the simplest way to think of what affects your credit is by looking at the 5 C's of Credit: Character, Capacity, Capital, Collateral, and Conditions.
In the next few sections we will look more in depth at what factors can affect your credit score.
Credit Score Factors
The following five factors are the main factors that affect your credit score. We will go through each one, as well as the overall weight they have on your credit score. While some factors may carry a heavier weight than others, they are all important to consider.
Payment history (35%)
Do you even have a payment history, or have you only had and been paying debt for a short time? Do you have a history of making consistent, timely payments on your debt, or do you often have late or even missed payments? How does this differ on your different accounts, such as credit cards or large loans?
It reflects positively on you if you have had a history -- over a period of time -- paying your debt on time, every time. Late payments will reflect poorly on you, and they will show late payments on credit report.
Credit utilization (30%)
Do you utilize all of the credit available to you? Do you maintain low credit card balances and refrain from maxing out on your credit card limits?
It reflects positively on you if you utilize some, but not too much, of the credit available to you. FICO says that the sweet spot is usually around 7%.
Credit history (15%)
Do you have a history of credit? Have your accounts been open for a long time? Have you not had any recent activity on your accounts?
It reflects positively on you if you have a history of maintaining healthy credit, including having accounts open over a longer period of time.
Credit mix (10%)
Do you carry a mix of different kinds of credit?
It reflects positively on you if you carry a mix of different kinds of credit, including revolving credit and installment loans.
New credit (10%)
Have you opened a lot of new accounts recently, or have you even requested to open a lot of new accounts recently?
It reflects positively on you if you get new credit; however, opening too many credit lines at once will reflect poorly on you, as it may be a sign of financial hardship.
Conclusion
Ok, opening, using, and closing credit cards affects your credit score. Then I tell you that not having any credit cards affects your credit score. Oh yeah, and that having too many credit cards affects your credit score. You may be asking yourself, "Well, is there anything I can do right?! Or is everything going to negatively affect my credit score??" I'll be honest, it's complicated.
As you can see from this article, everything will impact your credit score - both in positive and negative ways. You can't get around it. BUT with this knowledge, you can get ahead of the game. You know now how credit cards affect your credit score. Now you just need to find your own balance. If you take away anything from this, remember: Use your credit cards responsibly.