Credit card use has increased since its introduction as a payment method. It has made online purchases and paying for household expenses faster and more convenient. Unsurprisingly, there are 2.8 billion credit cards in use globally.
Using this financial tool comes with several advantages. However, every action involving your credit card can either help or damage your credit score, from the application to your usage habits and payment history. Even the choice not to use one can significantly influence your credit score.
Understanding the effects of opening, closing, and using credit cards can help you make more informed decisions about whether to apply for a new card or how to manage existing ones. But first, let’s explore what makes up your credit score.
Understanding What Makes Up Your Credit Score
A credit score comprises a three-digit number, ranging between 300 and 850, demonstrating your risk of repaying loans and credit card dues.
Landlords, lenders, and employers may run a credit check to verify your identity and financial dependability. A score of 800 or above within the same range is considered excellent. It indicates that you’re trustworthy when handling your credit and finances.
Several elements contribute to your credit score. Being aware of them is an excellent starting point for building good financial habits that will positively influence your score and help you achieve your financial goals.
Based on the FICO scoring model, the most significant factors that determine your credit scores include the following:
- Payment history: How you make payments on your financial obligations is the biggest factor that makes up your credit score. It constitutes 35 percent of your score, whether you’re paying late or on time.
- Credit usage: The second most crucial element is credit usage, representing 30 percent of your credit score. You can determine it through your credit utilization ratio. It reflects the amount you currently owe divided by the total credit available.
- Length of credit history: How long you’ve established your credit and how long you’ve been using it accounts for 15 percent of your credit score. Whether you’ve had credit for six months or ten years can considerably influence your credit score.
- Credit mix and types: Ten percent of your credit score comes from a mix of credit you use. Credit scoring systems favor a combination of revolving accounts like credit cards and installment loans.
- New credit applications: Every new credit application is reflected in your credit score. How frequently you’re opening a new account or line of credit makes up another 10 percent of your credit score.
Learn to make smarter choices with your credit by knowing the potential impact of recent credit applications and other credit card activities below.
Potential Impact of Credit Card Activities on Your Credit Score
Credit cards can shape your credit score in several ways. Using it responsibly and regularly can effectively help build or rebuild your credit. However, there are alternative resources available to learn how to improve your credit score without a credit card.
Nevertheless, your credit card activities can either help or damage your credit score. Discover the critical role of credit cards in calculating your credit score.
Applying for a new credit card
A credit card’s impact on your credit score starts when you apply for one. The process includes a hard inquiry on your credit report, reflecting a lender’s request to check your credit. It’s usually made when they decide whether to approve your credit application.
A hard inquiry remains on your credit report for two years. While its effect is relatively minor and short-lived, it can still damage your credit score. That’s particularly true when you submit several applications for new credit accounts.
If you have a long credit history, opening a credit card account lowers your average account age, which can decrease your credit score. On a positive note, opening your first credit card account can be a powerful way to build a credit history.
Using a credit card
Since payment history is the largest portion of one’s credit score, paying your credit card balances on time can boost your overall credit health. Conversely, paying late or missing payments will negatively affect your credit score.
If you can’t afford to pay your credit card in full each month, maintaining a credit utilization rate below 30 percent across your credit accounts is a good idea. Besides hurting your credit utilization, maxing out your credit cards can make keeping up with payments burdensome as interest charges accumulate.
When using your credit card, the timeliness of your payment is the most critical element affecting your credit score. Some lenders and creditors only report late payments on most accounts when they’re 30 days past due. Still, it’s a good idea to make prompt payments every month to uphold your creditworthiness.
Closing a credit card
If keeping a credit card open seems impractical, you might want to consider closing it. But before doing so, you must know that closed credit card accounts can change your credit score in many ways.
Closing a credit card account lowers the overall amount of credit available. This can raise your credit utilization rate if you have debts or balances on other accounts. Leaving the accounts open may help increase your available credit in relation to the amount of debt you owe.
Meanwhile, the impact of a card closure may be minimal if you pay off your monthly balances on time and have other accounts with a long credit history. Before closing your credit card account, paying off all your balances may be beneficial to avoid a dip in your score.
Having multiple credit cards
Depending on whether you pay bills or carry a balance, having multiple credit cards can either boost or lower your credit score. It’s easier to miss payments and incur fees for late payments when you’re managing more than one card.
But suppose your credit utilization ratio is less than 30 percent of your existing credit limit and you always make prompt payments in full. In this case, owning multiple credit cards can help improve your credit score. Note that it’s not advisable to get a lot of cards in a short period of time.
Practice Responsible Credit Card Management
When used with discipline, a credit card can be a valuable tool for enhancing your credit score and financial situation. Keeping credit card balances low and your accounts open and active is critical to ensuring your credit cards don’t damage your credit score. However, monitoring your credit reports and examining your credit scores regularly is essential as well.