There are two schools of thought on credit cards – one is that they are evil and we shouldn’t use them at all, and the other is that they’re a tool and can be used for good. I tend to fall somewhere in the middle of this debate, knowing that debt is inherently bad, but that we can still use the tools available to us to our advantage.
If you’re wondering how to make your credit cards work for you, it’s not through airline miles and bonus programs, but through a series of little-known facts about the world of credit cards that affect your credit score and your ability to get out of debt.
The first order of business is to know your interest rates – if you don’t know these figures off the top of your head, go find out right now. By logging into your online bank and pulling up a recent statement, you can find out what your current interest rates are.
Huh, that’s funny, why is it buried 3 or 4 pages deep and in fine print? That’s because they don’t want you to think about this number! In fact, most times you will discover there is more than one number – there’s an interest rate for purchases, and a separate one for cash advances. If you’ve ever transferred money from your credit card to your checking account in a time of need, you are likely paying around 25% interest, even though your regular purchases might be around 16% (which is still a lot of interest!).
High interest rates on credit cards is what keeps many people in debt far longer than they need to be. Knowing these numbers and having them in mind will help deter you from using your credit card at all unless there’s a true emergency, which is what a credit card should be used for in the first place.
While trying to get out of debt, it’s tempting to just pay the minimum on your credit card until you “have more money” – if I have one take-away, this is it: IT’S A TRAP! The minimum payment trap is a clever way for the banks to collect the most amount of interest from you for the longest period of time, while you crawl towards a zero-balance at the pace of a DMV line. Anything extra you can put toward your credit card balance will get you out of debt faster and save you exponential amounts of money in the long run.
Another credit card secret is the zero-balance myth; while the goal is always to get out of debt entirely, leaving a small revolving balance on your credit card is actually good for your credit score. Many people believe that paying off a credit card will boost their score, but in reality it can hurt you – a huge factor in scoring is your credit utilization ratio, which shows how much you use compared to your limit. Anything under 10% utilization is ideal, and raises your score, but if it goes down to zero, this actually lowers your score.
If you have a credit card with a $10,000 limit and you currently have a $5,000 balance on it, that would be a utilization ratio of 50% – you are using half of your available limit. If you pay that card down to $800 out of $10,000, you’re left with a utilization ratio of only 8%, which will boost your score significantly. However, if you pay that card down to zero, then you don’t have a utilization rating at all, because zero divided by anything is zero!
Keeping a small balance on a credit card is a great way to boost your credit score without working very hard, and is a small price to pay for good credit if you’re looking to purchase a house or a car that requires pulling your credit. The same goes for closing a card – if you’re all paid up and don’t want the temptation anymore, then by all means close it, but be prepared to see your credit score drop a bit; leaving unused accounts open helps your score by adding to the number of open accounts you have.
Speaking of great ways to boost your credit score with very little work, requesting a credit limit increase is my favorite way to improve credit without paying anything! Using our $10,000 balance card scenario again, an easy way to reduce the pain of that $5,000 balance is to simply raise your limit. If your $5,000 balance is now out of $15,000 instead of $10,000, you’ve improved your credit utilization ratio from 50% to 33% without paying a dime! If you get a credit limit increase to $25,000 then your balance is only 20% – this isn’t a get-out-of-debt scheme, but it will boost your credit score while you’re sorting things out.
Did you know that you can request a credit limit increase at practically any time? I used to think that a bank had to extend an offer to increase my limit, but in reality you can request an increase on any of your credit cards practically whenever – the only exception is if you’ve recently bumped up your credit limit, then you might have to wait a few months before trying again.
Don’t be discouraged if you have a large balance either – many banks offer more to lenders when they’re actually using a card, versus someone that doesn’t use it at all. If the bank says no to your request, wait a few months and try again; if you get a raise or pay down some of your balance, it changes their calculations, so be persistent – and don’t put any more money on that card, or it will defeat the purpose!
Gaining freedom from debt is always the goal, but the reality is that we live in a society that revolves around our credit worthiness, so keeping this balance in mind is key. Arming yourself with information is the best way to fight your way out of debt without hurting your credit score, and knowing what you’re up against is half the battle.