In today’s economy, it’s extremely important to have the best credit you can. Having a high credit score can help you to receive a lower interest rate on a home mortgage or a car loan, and can even result in more favorable insurance rates. And when you are trying to improve your credit, it’s important to consider what the best method of payment is.
How Different Payment Methods Affect Your Credit
Most forms of payment have no effect on your credit. Clearly, your use of cash or checks will not be reported to any of the major consumer credit bureaus, and it won’t impact your credit history or credit score in any way. It’s also a popular misconception that using a debit or a prepaid card will help your credit. When you use a debit or prepaid card, you aren’t being extended any credit. And since your credit history and credit score are designed to reflect your ability to repay a loan, debit and prepaid cards are not included in it.
However, credit cards require repayment and each purchase is considered to be a loan. Unlike other forms of payment, you will always receive a monthly statement when you use a credit card. And each month that you’ve made purchases or have a balance, you will be required to make a minimum payment on or before the statement’s due date. All of these payments are reported to the three major consumer credit bureaus, and your on-time payments will help your credit history and raise your credit score.
In fact, your payment history is the most important factor is used to make up your FICO credit score, representing 35% of your score. But with no payments to make, your debit or prepaid card will not contribute to your credit score.
For example, you could have a debit card issued by your bank that is linked to your checking account, but nothing about it will be reported to the credit bureaus. There are many prepaid, reloadable cards like the American Express Serve, the NetSpend Visa, and the AccountNow Visa. Even those these cards look like credit cards and are part of payment networks such as American Express and Visa, you must load money on them first, so it is not a loan. And since it is not a loan of any kind, it will not appear on any of your credit reports.
The Potential Dangers of a Credit Card Usage
Although using credit cards can allow you to build a credit history and increase your credit score, there are many potential dangers to their use. The most serious one is debt. Many credit card users will spend more than they would with other forms of payment such as cash or debit cards, since a credit card will allow you to spend more money than you have.
Making unnecessary purchases is also wasteful, and when you fail to pay your entire balance in full, you will incur costly interest charges. As unsecured debt that is never tax deductible, credit card interest charges will be more expensive than student debts, a home mortgage, or a car loan.
Furthermore, carrying a large amount of debt will hurt your credit score. Your debt comprises 30% of your FICO credit score, and is the second highest factor right after your payment history.
Finally, many credit cards offer you rewards for your spending. Although these rewards can be valuable, too many credit card users find themselves overspending in order to earn additional rewards.
How to Safely Use Credit Cards to Help Build Your Credit History
The interesting thing about credit cards is that having an account open and in good standing adds to your credit history, even if you don’t use your cards that often. Your credit history contains all of your credit card accounts, and your payment history for each. Whether you make a single charge each month, or use your credit card for all of your everyday purchases, the report made to the credit bureaus will only list your statement balance and whether you made your monthly payment on-time.
Therefore, there’s an easy way for you to use your credit cards to build credit while avoiding debt and costly interest charges. If you simply use your credit card for a few small transactions each month, and are careful to pay your statement balance in full each month, then you will avoid both debt and interest charges. At the same time, your credit history and credit score will reflect your on-time payments to accounts that are in good standing.
Getting a Credit Card When You Have Little Credit History or Poor Credit
As you try to build your credit, one of the problems you might face is being declined for a standard credit card due to your credit history. Thankfully, there are secured cards that are offered to nearly everyone, regardless of past problems with their credit.
A secured card works much like a standard credit card, except it requires payment of a refundable security deposit before your account can be opened. But once your account is opened, you will have many of the same benefits and responsibilities of any other credit card. For example, you will receive a monthly statement, and you will have to make a payment each month of at least the minimum balance. And if you choose to carry a balance, then you will incur interest charges.
However, secured cards will appear on your credit report just like any other credit card. You will build a good credit history by making your payments on-time and having a very low amount of debt. In addition, secured credit cards can offer valuable benefits such as extended warranty coverage and rental car insurance.
With a perfect record of on-time payments for one year, many secured credit card users find that they are able to qualify for standard, non-secured credit cards. They can then cancel their secured card and have their deposit refunded.
By understanding how credit cards can help you to build your credit, you can safely use these powerful financial tools to help you achieve the credit you deserve.
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