The first thing to understand about how credit cards affect your credit score is, your score is only affected when the company issuing the card reports to one of the three major credit bureau’s, these being Equifax, TransUnion, and Expirian. Most Issuing banks report to all three however a few secured credit card companies do not. If you are looking to rebuild your credit by means of a secured credit card then it is important to find out if the issuing company is reporting to the credit bureaus.
When a credit card issuer’s reports to your credit report you are establishing a track record so to speak. This track record allows lending institutions to see how well you are able to pay back debt. The idea behind it is, if you have paid back what you owed in the past chances are you will be able to pay back what you owe in the future. This is a simple definition however there are many facets to this picture. To illustrate it think of it this way.The credit bureau’s are like your teacher, you credit score is like a report card, and your credit history is what you are graded on. One part of your credit history you are graded on is your credit to debt ratio, this aspect can be impacted greatly by credit cards. The following will explain how.
Credit cards and credit to debt ratios
Let’s say that you have two credit cards, and each one has a limit of $10,000. Now let’s say that you consistently carry a balance of $5,000 on one of the cards. With two credit cards, your debt to available credit ratio is $20,000/$5,000 [total credit available/total debt]. This means that you would be using 25% of your overall available credit; this is a good place to be. Now if you where to close one credit card, your ratio would now be $10,000/$5,000, which would lower your overall credit score since you would now be using 50% of your available credit.
One way to improve your credit score with credit cards
In light of the above paragraph could a person improve their credit simply by gaining another credit card? Yes. For example if you had one credit card with a limit of $5000 and you carried a consistent balance of $2500 on it then your debt to available credit ratio would be $5,000/$2,500 [total credit available/total debt] This means that you would be using 50% of your overall available credit however if you gained a second credit card with a limit of $5,000 and put a balance of $500 then your debt to available credit ratio would be $10,000/$3,000 which means that you would only be using 30% of your available credit and your credit score would improve.
Why some are considered Risky
Basically in the eyes of the lending institution if you are always using all of your available credit then you fall into a group of people that might be over extending themselves and according to history people who over extend them selves have a greater likelihood of defaulting on money they owe, thus if you put yourself into this group your score will go down. Although the above is true there other factors, for example if you have too many credit cards then you could be seen as having the ability to be at risk in the future if your income or capacity to pay is not equal to your credit limit. And if you don’t have any credit cards than you are not establishing credit history at least not with credit cards.
Watch out because this can hurt you
Many credit card issuers allow card holders a grace period. This means that if you pay you bill every month in full you will not be charged a percentage rate or APR. If you have a card with a credit limit of $5,000 and every month you charge $1,500 but you pay it off every month in full you will avoid finance charges but it could be hurting your credit score why. Because when credit card issuers report to you credit report all they report is how much you owe and that you pay on time not the fact that you pay your balance in full each month. So on paper it looks like you always have a balance of $1,500 and that you never pay it off. It might be wise to switch between cards every few months so that you can show a balance of zero from time to time, this will help your credit score. And if you are planning to buy a house, pay off your credit card balance a few months in advance so that you have a good debt to available credit ratio as this could save you tens of thousands of dollars over the course of time on your mortgage.