Best Practices Explained – Forbes Advisor

Credit cards offer lucrative opportunities to build credit and earn rewards. But when not used responsibly, they can lead to spiraling debt. The best way to use a credit card is to avoid paying interest by paying off the balance every month on time. Interest rates, known with credit cards as Annual Percentage Rates (APR), apply to purchases, cash advances and balance transfers for most credit cards. Generally, cardholders want to avoid paying interest whenever possible, but there are several important steps to take when learning how to use a credit card.

How To Use a Credit Card

Using a credit card is as simple as you make it. A few basic rules you, as a cardholder, can follow for the extent of your credit card’s life will keep it easy. Among these are two key pieces of wisdom: Don’t spend more than you can afford and pay off your balance every month on time. Understanding how credit scores work can also help you control and increase your credit score over time.

When researching your first credit card (or any card, for that matter), you’ll want to find one that works for you and your current financial needs. Secured and student cards provide useful options for people who need to build credit from scratch.

Pick a Card That Works for You

The first step in shopping for a credit card is considering your spending habits. For example, could you benefit from earning cash back on gas or groceries? Do you frequently travel and want to earn points or miles? Are hotel discounts important to you?

These questions can help you decide what type of card you want and which potential rewards would be most helpful to you. Start researching by comparing credit cards among card issuers or banks, like Chase, Capital One or Citi. Use a card comparison tool if you need help comparing offers. Forbes Advisor provides an array of lists and other resources to help you cut through the plastic jungle and find a path lined with cards to fit your specific needs.

After narrowing down your options and evaluating which card issuer you may want to work with, look at each card’s terms and conditions to be aware of potential fees, payment due dates and restrictions to using benefits. Make sure you can afford any annual fee a card charges and look at APRs, promotional APRs and welcome bonuses.

Always Make Payments on Time

One of the most essential rules to owning a credit card is paying bills on time. A single late payment within a year of on-time payments might not seem to be much, but it could be a slippery slope that leads to debt and low credit scores and it will impact your credit.

Your payment history is important because it makes up 35% of your credit score, which banks and other lenders use to determine whether you’re a risky credit borrower. Late payments tend to spiral—cardholders get hit with late fees and interest charges that are hard to pay off, then credit scores fall as debt rises. Later if cardholders in debt want to apply for a mortgage or auto loan, they could face higher interest charges due to a low score and increased risk of default.

You can avoid missing payments by setting up auto-pay or setting reminders on your phone.

Card issuers calculate minimum monthly payments for cardholders based on monthly balances. Cardholders must pay the minimum amount to keep an account in good standing and avoid late fees. Minimum payments can be as low as $25, but it likely won’t cover all of your purchases for an entire month. Any remaining balance will be charged interest in the next billing cycle.

Most credit cards give cardholders a grace period of at least 21 days to pay off a balance without being charged interest—this is called a grace period. Some credit cards do not provide grace periods for purchases or other types of charges. Always read the terms (including payment due dates and billing cycle length) before applying for a credit card.

Spend Only What You Can Afford

It’s tempting to think of a credit card as an endless supply of borrowed money but it’s imperative to remember credit cards are not consequence-free. Your credit limit is the maximum amount you can charge to a card, and you have to pay back everything you spend (plus interest or even fees if you miss a payment).

The average credit card interest was 16.17% as of February 2022. Paying interest on a credit card balance will quickly cost more than the value of any rewards you have earned. By restricting your card use to only what you can afford, it will be much easier to pay off your balance in full every time and avoid being charged large amounts of interest each month.

Maxing out credit cards or ever-increasing interest charges can lead to high credit usage—also a dangerous game with your credit. A cardholder’s credit usage, commonly known as a credit utilization rate (CUR), is the second-most important factor affecting credit scores.

Your CUR is the amount of credit used compared to the total amount of credit available. For example, if your card limit is $10,000 and you have a rotating balance of $3,000, you’re using 30% of your available credit. Experts recommend keeping your CUR below 30%, but the ideal range is much lower.

Spending only what you can afford makes it much easier to stay out of credit card debt. If you’re getting your first credit card, think of it as a debit card in the sense that you don’t want to spend more money than you have in your bank account. Only a certain amount of money is available in your bank account each month, so don’t spend more than what’s available minus other bills like phone payments, rent and more.

Understand How Credit Scores Work

Part of using a credit card is understanding how credit scores can work for or against you. Lenders use credit scores to determine whether applicants are risky borrowers. The higher the credit score, the more it proves to lenders that someone is a responsible borrower who makes payments on time, pays off balances and has a healthy mix of credit.

Three major credit bureaus (Experian, Equifax and Transunion) use slightly different scoring models to measure credit scores. The FICO model is used by 90% of top lenders. FICO credit scores range from 300 to 850—from poor on the low end to exceptional at the high end:

• Poor: 350-579
• Fair: 580-669
• Good: 670-739
• Very good: 740-799
• Exceptional: 800-850

Payment history and credit utilization make up a big part of your credit score, but so do the mix of credit types, length of credit history and the number of recent credit card applications. A high credit score means you’re more likely to be eligible for lower interest rates when taking out big loans for mortgages or car purchases.

How To Build Your Credit Score

Now that you know how credit scores work and what factors affect your score, let’s see how you can build your credit score from scratch or rebuild from a low score.

Remember the factors affecting credit scores:

• Payment history
• Credit utilization
• Length of credit history
• Credit mix
• Recent credit card applications

Besides paying your bills on time and in full, let’s look at the other ways to increase your credit score.

Keep Your Oldest Account

Length of credit history can affect up to 15% of your credit score, making it the third most important factor. No matter where you’re at in your credit card journey, you might want to keep your oldest account open as this will help increase the length of your credit history.

For example, consider a no annual fee student credit card if you have the luxury of “student” status. Student cards have lower requirements to qualify yet still often offer good terms, making them a great option for kicking off a credit history. Even if you get a second credit card a few years later, keep your student account open for as long as it’s feasible—your credit score may grow as a result.

If you no longer find a card useful, consider doing a product change to another card instead of closing the account altogether.

Don’t Apply for Too Many Cards at Once

While it may seem counterintuitive, you don’t want to apply for a stack of credit cards to see which one you can get. Most card issuers perform hard credit checks during the application process, which can temporarily lower credit scores. Keeping up with payments can help a score rebound, but too many applications in a short period can have a lasting negative effect.

The best practice is to research which credit cards are best suited to your needs first, narrow the list down to two or three cards and finally, pick one to apply for. If the first application isn’t approved, try again for a different card. If the second one isn’t approved, wait a few months before applying again. You may need to improve your credit score to qualify for certain cards.

When available, use a card issuer’s pre-approval tool to know which cards you qualify for. Pre-approval tools typically result in soft inquiries with no impact to a credit score. Receiving a pre-approval for a card can also inform you of which rates, fees and terms you may receive if you follow up with a formal application.

Keep Balances Low

Keeping balances low is one of the best ways to build or rebuild credit at any stage. Credit utilization is the second biggest factor affecting credit scores. Experts recommend cardholders keep credit utilization under 30%.

The best way to keep balances low is to spend only what you can afford and pay every bill on time.

Consider a Secured Card

Secured credit cards can be helpful for people rebuilding credit or starting from scratch as long as the card issuer reports credit activity to all three major credit bureaus. Secured cards require a small security deposit (as low as $200) that becomes the card’s limit. Some secured cards offer no annual fees and even cash back potential.

With responsible use, card issuers may upgrade a secured account to an unsecured or traditional account and return the cardholder’s deposit as a statement credit (or send a check if the cardholder closes the account).

How To Earn Rewards

Besides earning a high credit score, credit cards can be lucrative because of a high reward potential. When picking your first, second or even third credit card, think about which types of rewards would match your spending habits the best.

In short, you can earn rewards by spending money using your credit card. Rewards tend to come in one of three flavors: cash back, transferable rewards and fixed-value points or miles. Each comes with pros and cons, but remember that no matter which type of credit card you choose, any rewards you earn will be quickly eclipsed by interest and late fees if you’re unable to pay off your balance every month.

Rewards cards may have annual fees or restrictions on how and when you can use your rewards. Because rewards cards are generally more attractive to consumers, they tend to require higher credit scores than other types of credit cards.

Cash Back

Cash back means you receive a cash reward for making purchases with your card, usually in the form of a deposit, a check or statement credit. It’s usually calculated as percentage points of certain eligible purchases each month. Depending on the issuer, there might be limitations to how much you can earn or how you can earn.

For example, the Chase Freedom Flex℠ earns 5% cash back on up to $1,500 in categories that rotate quarterly (requires activation), 5% on travel purchased through Chase Ultimate Rewards®, 3% on dining and drugstores and 1% on all other purchases. Your points don’t expire with this card as long as your account remains open and in good standing but other card issuers might put expiration dates on cash back rewards.

Transferable Rewards

Transferable points tend to be more flexible for many cardholders. For example, you can often redeem points for travel directly like cash back, transfer points to partners, redeem for retail purchases and even memberships to popular services like gyms depending on a card issuer’s partnerships.

The value of your points will depend on the card issuer and what you redeem them for. Popular travel cards like the Chase Sapphire Preferred® Card have a higher point value for travel purchases than retail purchases. Points are redeemable on Chase’s online portal, Chase Ultimate Rewards.

Airline or Hotel Points and Miles

Some card issuers offer co-branded credit cards in partnership with major airlines and hotel programs. For example, Delta, United, Southwest, American Airlines, Hilton, Hyatt and Marriott all offer credit cards with various card issuers. The downside to earning points and miles that are associated with a specific airline or hotel is that they can typically only be used with the card’s partnership airline, the airline’s partner airlines or the hotel and may only be redeemable for travel-related purchases like flights, upgrades or seat assignments and hotel nights.

The value of points and miles can vary from program-to-program and even between different times of the year. If you’d like to apply for a co-branded airline or hotel card, figure out which airline or hotel you travel with the most and take the plunge (but only if it makes sense).

Bottom Line

Credit cards can be a powerful tool in your wallet but they can quickly become a liability if not used properly. Remember the key principles to using credit cards: spend only what you can afford, pay bills on time and pay off the balance every month. If you find yourself in debt, remember there are ways to break out of it with discipline and attention. It’s never too late to start spending responsibly and earn rewards with a credit card.

This is ultimately your decision—what works for your friends or family may not work for you. So ensure you pick a credit card that’s right for you. Applying for a credit card is a major financial decision with myriad credit and financial implications and responsibilities; make sure it’s worth it.

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