Whenever you’re venturing into the world of credit cards, more often than not, new users don’t fully understand what it means to use their credit card. In other words, why spend money and pay a bill when you can just swipe your card and not have to worry about it? Well, credit cards are arguably one of the most powerful tools in our society and day-to-day life. Besides giving you credibility for future loans or major purchases, credit cards can also give great rewards if you know how to use them wisely.
Debit v. Credit
A debit card is simple. It is a card that when used, it takes money directly out of the checking account it is linked to. Therefore, you are limited to the amount of money in that account. Debit cards also give you access to ATM machines where you can withdraw cash directly from your account with a personal identification number (PIN). Simply, a debit card is a cash card for your account.
On the other hand, a credit card allows users to borrow a set amount of funds to pay for whatever they need at any given time with the ability to pay it back later. These funds are an extended line of credit from a financial institution. Depending on the institution and the terms, users have anywhere between 21 to 30 days after their statement closes to pay off their card without any interest or fees.
Unlike debit cards, users have to apply to get a credit card which is based on a number of factors, otherwise known as creditworthiness. These factors can include the amount of credit accounts a person has, how long their credit history is, what their current household income is, their credit score, etc. The better their creditworthiness, the more likely they are to get approved and the higher the limit they will receive.
Credit cards are great because you could pay for things now and worry about it later. This allows you to make larger purchases you may not have the money for at that given time. Or you have time to pay it down instead of having to provide the money on the spot. A debit card restricts you to the funds in your account, whereas with a credit card you are responsible to later repay whatever you spend.
So, what’s a credit score and how do I build it?
A credit score is like your reputation. It takes a long time to build up but its easy to ruin. A credit score is a scale that determines a person’s creditworthiness and how willing lenders will want to extend credit and loans to you. This scale ranges from 300-850. The following is what makes up your credit score:
The most important component of your credit score is your payment history. This factor shows the lenders how reliable you are when it comes to paying back a loan. Payment history includes whether or not you make your payments on time, how often you miss payments or make late payments, when you make your payments back, etc. The more on-time your payments are, the better it is for your credit score.
Another component is how much you owe. Do you max out your cards or use them conservatively? How much of your credit do you utilize each month or at any given time? What is the ratio between the credit you have and the money you spent? The lower the amounts, the better it is for your score.
Length of Credit History
Many times you will hear people say, don’t close your first credit card - this is exactly why. Your credit score is partially determined by how long you actually had a credit account. The longer the account is open, along with on-time payments, the better it is for your score. This gives lenders and financial institutions something to look through when determining whether or not to extend a loan.
Types Of Accounts
Credit cards are not the only thing that determines a credit score. Other types of loans like home or auto loans can play a role in it as well.
This factor is there to ensure that you aren’t in financial trouble. If someone is applying for a lot of cards in a short span of time, it may suggest some financial risk on their part and therefore will lower their score. It’s good to keep applications and inquiries low to help better the score.
Building a score takes time and conscious effort. There are so many different credit cards that offer great perks, points, rewards, miles etc. However, being smart about how you use them can go a long way to building your score. The most important thing you can do is make sure to spend responsibly and make your payments on time.
Written by: Erica Dushey Sarway