How Credit Cards Affect Your Credit Score

“Back in 2007, when my Uncle Tom decided to buy a dream retirement house in countryside, he approached a local banker. Being a decent earning executive, he still had 10 years for retirement. To his utter shock his loan application was rejected on the grounds of no credit history. Shocked, he approached the banker and explained he never felt a need to take loan or credit card in the past as he always lived within his means. The banker understood his concerns but was bound by credit rating guidelines and could help him much. ”

This might not be the story of many people now days, given the bunch of credit cards we carry in our pocket. But this does portray the relationship between credit cards and credit scores. Having a credit card is a double-edged sword which can make help you build a good credit history but at the same time it can even ruin your score in case you don’t make few of the common credit card mistakes.

Banks and Credit ratings 

When you apply for any loan, credit checks are done to calculate your eligibility to repay it. In order to determine your potential to do so, they check your credit history of repaying previous loans. Timely payment of your previous loans will certainly help you get a few good points. Source of regular income is also one of the major factors which are taken into account while approving your loan application. Similarly Credit card payment history too plays major role in your credit history.

How credit cards impact your credit scores

All the major credit rating agencies collect your lending history from major banks and then apply a trade secret formula to come up with your credit score. Credit cards form a major component of your score as it shows how you handle your debts and borrowings. A good credit score will not only get you best possible interest rate deals but will open avenues for various types of loans.

Time span of credit History
Whether your credit history is good or bad, its time period is considered in your score. A longer good history is always preferred by lenders.

Too many credit requests can damage your score
Studies suggest people who look for credit options often are more likely to get into tough financial situations. In case you don’t need cash for urgent news, it’s better to use your credit cards sparingly.

Lower the credit utilization better it is
A credit utilization ratio is comparison of credit used and total credit available on card.  Lower the credit utilization ratio the better it is as far as credit score goes. For example you have credit of $2000 on $4000 credit limit card; your utilization ratio will be 50%. At the same time you decide to get another card of same $4000 limit, and you buy nothing new using it, then your ratio will drop to 25% which is good. You can use this technique for few cards in order to get your score levels to soar up to certain limit.

Giving away old credit cards won’t do much good to you
By surrendering your old, rarely used card you are not going to your scores much favor as your credit utilization ratio will rise. So instead of returning the card you may just keep it away and stop using it completely.

Late payments or high balances will damage your score
As I said you are carrying a double edged sword in the form of credit cards, don’t let yourself get burdened by such a heavy debt that you are unable to pay it off. Late payments ruin your credit scores to a great extent and are a blotch in your credit history.

As the world recovers from sub-prime crisis, credit rating parameters will undergo further scrutiny from lenders and will become stringent. It is advisable to be cautious and take necessary steps to control the damage done in past rather than regretting it later with respect to credit history.

Don’t be afraid of a small plastic card sitting in your pocket but at the same time use it well to get the best benefits and deals available.

Read More:
Common Myths about Credit Cards
Understanding Credit Card Billing Cycle and Grace Period
Revolving credit v/s Overdraft
Few insurance policies you need not buy

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